by Mike Moyer
For instance, if an investor buys 50% of the pie for $1,000,000 the pie is now “worth” $2,000,000 as long as the money stays in the business instead of being passed on to the original shareholders. So, now the pie is bigger.
The founders were able to convince an investor that the original pie was worth $1 million (this is called a “pre-money” valuation), the investor put in another $1 million, so now it is “worth” $2 million-get it? If you had half of the original pie your piece was valued at $500,000. Now you have 25% of the pie and it is still worth $500,000.
If a few months later someone buys half the company for $3,000,000 in the next round of financing, now the whole pie is worth $6,000,000.
The original pie, before the investment, had grown to be worth $3,000,000. Now your share, which was 25% of the original pie, or 12.5% of the new pie, is worth $750,000. Your equity stake has dropped from 25% to 12.5% but the value has grown to $750,000.
At the end of the day, the cash value of your equity is much more interesting than your percent ownership. Notice that while your percentage is shrinking, your wealth is growing.
It is funny how often people lose sight of this simple concept. Pies get bigger and bigger as value grows. Equity grows and grows. People who think equity is a finite resource are wrong. I once worked for a guy who was so paranoid about giving up “all the equity” that he couldn’t sleep. He was a fool.
As long as a people are willing to pay more and more for your company’s equity the value of your shares will also grow, regardless of what percent ownership they represent.
Of course there are situations where companies lose value in which case you lose value too. If the next guy invested $1,000,000 for half the company instead of $3,000,000 the company would be worth $2,000,000 and your 12.5% share would be worth $250,000.
Sometimes the company issues different “classes” of equity that might dilute the value of your shares. There are a number of possibilities that are beyond the scope of this book. There are people who make a nice living figuring out stuff like this-I’m not one of them.
The moral of the story: concentrate on building value and don’t worry about percentage ownership. Don’t get hung up on it. Pies can grow beyond your wildest dreams. If you don’t think so, think about Google, Microsoft, Groupon, Facebook and Apple.
It doesn’t really matter what you think the company might be worth someday. What matters is that people are treated fairly and they ultimately get a payout that’s fair given what they put in.
Sometimes pies grow-this is good.
Paying with Pie
Remember that “Gap” period I mentioned earlier? If you have no money, you can pay people with pie.
Using pie during the Gap means you will have to convince people that the pie has value before there are any real benchmarks. To do this you will have to be able to convince people that your business idea is great and that you (with their help) will be able to turn it into some cold hard cash in the not-too-distant future.
It is important to note, before we continue, that while paying with pie can be a great way to get your business off the ground and through the Gap, you must be careful not to make too many slices. In general, investors want to invest in a pie that is relatively intact. If it’s not, it will be less attractive. Investors want to see that all of the shareholders are actively involved in the business. While this is not always possible when you pay with pie, we will go over some ways to keep the pie relatively intact.
The other thing you will have to do is find people who are willing to work for pie instead of cash. Not everyone is willing to assume the risk that they will never get paid. However, I think you will find that a lot of people will take pie over cash if they think they are going to be part of an exciting new venture.
There is a word for people who will take pie instead of cash: “Grunts.”
Grunts
Grunts are people who are willing to forgo cash compensation in exchange for a piece of the pie. Grunts do the work necessary to turn an idea into a reality. They will do the fun work and the dirty work. They are as comfortable licking stamps as they are building a strategic plan.
Grunts ask for little in return-usually just pie. They can generally survive in sub-standard habitats. They have been known to thrive in garages, basements and spare bedrooms. They can be found lurking in coffee shops, college campuses and even within the cubicles and offices of a day job.
Grunts don’t need much. They are highly resourceful. They can act on scant little information and leap tall problems in a single bound. They are motivated by the dream of success.
Grunts are pack animals. They travel in herds. Rarely can a Grunt do all the work themselves so they offer some of the pie to other Grunts. If you can win the heart of a good Grunt, your idea will become a reality as long as you treat the Grunt with respect and fair play.
Grunts come for the pie
Baking Pies
In order to make tasty pie you need the right ingredients. These will be provided by Grunts. You, by the way, are a Grunt too. While the type of ingredients and amount of each will vary depending on the flavor of pie you are baking, the basic ingredients are as follows:
Time
Time is probably the most significant ingredient that a Grunt has to offer. Many people don’t have a lot of money, but they have time, especially early in their career or if the previous pies they helped make didn’t sell or grow the way they had hoped.
Grunts dedicate time turning ideas into pies. Not all time is created equal. The time of the experienced chief technology officer is worth more than the junior programmer. However, both people need to be treated fairly. If you have the right Grunts in the herd you will be fine.
Ideas
Grunts are a fountain of ideas for products, ideas for marketing, ideas for sales, ideas for operations. Good employees come to the table with lots and lots of good ideas. Remember, however, that an idea by itself usually has little or no value. It has to be made into pie first.
Relationships
All companies need relationships that can turn into customers, investors, partners or advisors. Sometimes relationships are built through the operation of the business and sometimes an employee brings pre-existing relationships with him or her to the table. Existing relationships can really accelerate the process and finding people who have these relationships is an important part of the process.
Intellectual Property
Patents, trademarks and other ways of doing things are intellectual property. As long as the individual has a legal right to use these assets they can be an important part of a fledgling business, especially when it comes to creating strategic advantages.
When a person joins a company and allows them to use their IP, the company should provide a fair slice of pie in return for a license to use the IP.
Funds
You can use pie to acquire a lot of the ingredients you need for your startup company, but not everything. Try buying stamps with pie. I’m pretty sure the postman will look at you like you are crazy. So you can put “stamps” on your list of hundreds of things that you probably can’t get with pie. So, sooner or later you will need to get your hands on some money. Money comes in the form of cash, loans and credit (which is similar to a loan).
Cash
Cash comes in the form of early working capital or covered expenses for which reimbursement is not expected. This is different than a significant angel or venture capital investment. This is money that helps get the business off the ground.
When you attract significant money the game changes. More on this later.
Loans
Loans from an individual to the company that are expected to be repaid.
Or…
Loans from a bank to the company to finance the purchase or operations of the company.
Credit
Credit comes in the form of personal credit card debt or company loans that an employee had to personally guarantee.
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p; Supplies and Equipment
Business-facilitating supplies and equipment are pencils, paper, personal computers or other items that make the business easier to operate efficiently.
The test here is whether the business could operate at all without them. Many Grunts, for example, use their own personal laptops during the formation-stages of a business. This is an example of equipment that facilitates the business. This is different than supplies and equipment without which the business couldn’t exist.
Business-enabling supplies and equipment such as data servers, printing presses, delivery vans or other items without which the business would not be a business in the first place.
For instance, if a couple of dudes are starting a pizza shop and one of them provides a pizza oven, that would be an example of a business-enabling piece of equipment.
There is often a fine line between whether supplies and equipment is business-facilitating or business-enabling. It’s often a judgment call. Take chairs, for instance. An employee shouldn’t expect her $1000 Herman Miller Aeron chair to be considered a business-enabling piece of equipment even though you need chairs. In most cases a $25 used office chair will serve the same purpose.
Facilities
Facilities that would otherwise generate income for the owner, include office buildings, retail locations, studio space or other facilities that the owner would typically rent out if the startup wasn’t using it.
In this case the owner has an opportunity cost of dedicating the asset to baking the pie.
If all the employees work out of a spare room in one of their houses, this wouldn’t count because the person probably isn’t planning on renting out the spare room in his house. If you and the other employees are a bunch of slobs, you may want to throw him or her a bone in exchange for using the spare room and making a mess.
Other Resources
Some Grunts may have access to resources that your company can use from time to time, company won’t actually own. For instance, a Grunt may have employees from another company that can work on your company’s projects on a part-time basis. Or, perhaps a Grunt has some equipment that your company can “rent” with pie.
While some ingredients are more productive than others, all should be treated as if they build positive value.
Why, you might ask, should I treat them all as if they build positive value? Because it’s not fair not to. If you are paying with pie you have to be fair. If a person does work on behalf of a company and that work turns out to be a waste of time you still got value. Specifically, you learned that that particular activity was a waste of time and you can avoid it in the future.
A friend of mine (a Grunt), grunted away for a guy for almost two years and followed the direction of the controlling partner. One day, on a whim, the controlling partner decided to abandon the original strategy in favor of another one. He fired my friend and took back all the equity because his work was not related to the new strategy. How could he have known? Ask yourself: is this fair?
Not all effort is productive, but it all counts
When a herd of Grunts agrees to dedicate their time, energy and resources towards a problem, it is impossible to tell, in advance, if it is going to work. It is not fair to judge the value of the inputs using the benefit of hindsight.
This makes a lot of seasoned entrepreneurs uncomfortable. After all, value creation is essential in any business. The more experience you have the more you can see, with 20/20 hindsight, where value was created. Many people mistake their ability to have good hindsight with their ability to have good foresight.
If this is you, take a break and think about how you might identify value creation before it happens. It’s pretty hard, even for smart people. (Hint: some Grunts have better track records than other Grunts. These Grunts should be allocated more pie because of what they are capable of because not all Grunts are created equal).
Startup companies are risk-taking entities. By devaluing an individual Grunt’s input based on hindsight, you are asking that Grunt to assume the risk on behalf of the herd. You cannot allow a single Grunt to bear the burden of risk for the herd-it’s not fair.
When there is a pie, Grunts will show up and help make the pie grow. A Grunt is happy sharing the pie with other Grunts as long as he or she was treated fairly in the process. In the end there will be enough for everyone if things go right. After all, there is virtually no end to how big the pie can grow. If your company fails the Grunt will try again someday as long as they were treated fairly.
If you have been an entrepreneur or worked for an early-stage startup filled with Grunts, you know there are few places on earth with more excitement, energy and passion. A herd of Grunts is a sight to be seen and a force to be reckoned with. When a Grunt is not in a herd, they are often pre-occupied with trying to find one or trying to build one. Sometimes Grunts join a number of herds. Herds of Grunts are great
The Proper Care and Feeding of Grunts
As I said before, Grunts don’t ask for much. You can pay them in pie, or at least partly in pie. They also need to feel as if they are part of the herd. Grunts thrive on their inclusion in the herd. That means their opinions are taken seriously and their contribution is valued.
It is important to feed a Grunt the right amount of pie. If you don’t feed a Grunt enough pie, they will feel undervalued and they might leave the herd. If you feed a Grunt too much pie, the other Grunts may feel undervalued, give up and leave the herd. Or worse, they will feel undervalued, give up and stay.
When employees give up and stay, the environment becomes plagued with resentment and low morale. Trust me when I say that these emotions are startup killers.
Using equity to compensate contributors, or slicing pie, can be one of the most important tools for attracting and maintaining a healthy herd of hard working Grunts when it is done right. When it’s done wrong you will have a lot of disgruntled Grunts.
As a Grunt myself, I’ve been the member and, in some cases, the leader of many herds. I have been in very few herds where all the members of the herd were fed properly.
I have also been in herds where I’ve been fed more than my fair share and I have been in herds where I have been fed less than my fair share. In all cases the relationships I had with other employees was strained because of the inequity.
When people slice pie they usually do it wrong. They make one of two mistakes. They either slice the pie before they bake it or they slice the pie after they bake it.
Before it’s Baked
The most common mistake entrepreneurs make is slicing the pie before it is baked. In my experience this is what about 90% of people do. They “do the deal” with one another up front because they think it will avoid arguments later on. This is rarely the case. There is always an argument. It may be one-sided and you may never hear about it because the other person left in a huff.
I was once in a business with a guy who didn’t understand the concept of growing pies. He thought equity was a finite resource as many people do. So, he set out to slice the pie for every possible Grunt that might come along. He was the worst slicer I have ever come across. Needless to say, I don’t work with him anymore and I won’t ever join a herd that he is in. He is a successful guy, but he just doesn’t understand startup pie very well so his ill-gotten success is built at the expense of others.
When Grunts succeed they should succeed together, when they fail, they should fail together.
The reason that slicing pie before baking pie causes so many problems is that startups change fast—really fast. You never know what is around the corner and it is impossible to anticipate what will happen. So, when things inevitably change, you and your fellow Grunts will have to endure painful renegotiations to set things right, or live with the inequity of the split. Either way relationships will suffer, sometimes beyond repair.
I’ve made the slicing before mistake more than once in my life and I’ve always regretted it. Several years ago I had an idea for a web site that
was destined to change the world. I was over-eager to get it started so I made the mistake of slicing the pie before I baked it. I gave a developer 75% of the equity to build the site. I kept 25% which was fine with me because I had planned on being a silent partner. Now it’s built…
In order for it to have any value, however, we need to market it. I’m a marketing guy; but, as a minority shareholder I have little motivation to dedicate my time to the project. I burned myself by slicing the pie in advance.
The developer is unfairly burned too. He’s a great developer, but he doesn’t do marketing. If we want to hire another Grunt to do the marketing work what do we do? Should I spend time finding someone and paying them out of my pocket? Should I put additional time in? Should the developer?
Our ownership is fixed. Maybe we can give the new marketing guy a chunk of the equity but who will give up their pie? Remember, the pie is pretty much the same size as when we started. We have a web site, but without paying customers it’s not worth much.
Should I give up more of my pie or should the developer give up his? Should we each give up the same amount of pie or do we give up in proportion with our shares? It’s a tough question and a tough conversation.
Even if we can work through it, it will take its toll on our relationship and it will certainly come up again before we’re done. I could suggest, for instance, that we start over and reallocate the pie. He will undoubtedly have less which will be annoying for him even though he knows that his current stake is worthless anyway. At the end of the day, the momentum and excitement has been sucked out of the business because of bad pie slicing. Renegotiation can be a company-killer.
