Slicing Pie: Fund Your Company Without Funds

by Mike Moyer

The following case studies are designed to help enlighten you with regard to the practical application of a Grunt Fund.

  All the examples and case studies are fictional (just like most financial projections). I’ll create more fictional case studies and post them on SlicingPie.com, please feel free to bring me your own problems and stories.

  Grunt Funds are all about action.

  The Case of:

  John’s Bicycle Attic, LLC

  John loves bikes and wants to start a bike repair service. He tells his friend Mike and they decide to start a bike repair shop in their basement and call it John’s Bicycle Attic and use a Grunt Fund to slice the pie.

  The only other job that either of them had was when they were dish dogs at the local country club. John, who was a dish dog longer than Mike, earned $10.00 per hour and Mike only earned $9.00 per hour.

  They appoint John as the president of the company because it was his idea and he has the most bike-repair experience.

  John provides a repair stand and a killer set of tools that enable the business.

  Over the next month John works 100 hours in the shop and Mike works 100 hours talking to bike owners and generating business. Mike spends $1,000 on flyers and ads for the company and he brings $100 in snacks for the shop from his home. He does not expect to be reimbursed.

  When using a Grunt Fund the first step is to figure out John and Mike’s Grunt Hourly Resource Rate (GHRR). Because they were hourly workers before, it’s okay to double their previous rate for their GHRR. This would give John a GHRR of $20.00 and Mike a GHRR of $18.00. Mike and John, however, are smart guys. They realize that fixing bikes isn’t the same as washing dishes and they agree they have complementary skills. So, they agree to take an equal GHRR of $20/hour. You don’t have to split hairs with a Grunt Fund. They keep it real.

  Next, they have to take John’s equipment into account. Because the equipment enables the business it should be assigned a theoretical value. John didn’t buy the tools specifically for the business so they looked up a comparable set of tools on Ebay.com and found some for around $1,000. So, the theoretical value of the business enabling equipment is $1,000.

  Mike also contributed to the business with supplies consisting of flyers, for which he paid $1,000, and snacks, for which he paid $100.

  The snacks, which he brought from home, are business facilitating supplies and should not be assigned a value. They are nice to have, but not critical. The flyers, on the other hand, were a business expense for which Mike does not expect to be reimbursed. The theoretical value of that contribution is the amount of cash times four.

  So, at the end of the first month John would own 33% of the pie and Mike would own 67%

  In the above example, the Grunt Model has properly divided the pie of the business among the two partners. Over the next month the partner’s commitments change.

  Mike gets a new girlfriend, Anne, and starts spending a lot of time over at her apartment. Over the next month he only spends 50 hours promoting the business and spends no money on advertising. John spends 75 hours in the shop and 75 hours generating business. He also spends $500 on advertising.

  At the end of the second month, John has committed 175 hours, $1,000 in enabling equipment and $500 on advertising. His total theoretical value has grown to $8,000. Mike has committed 150 hours and $1,000 on advertising. Hit total theoretical value has grown to $7,000. At the end of the second month John’s slice of the pie is 53% and Mike’s is 47%.

  As you can see, John’s pie slice grows to reflect his dedication to the business. If John and Mike had simply split the business 50/50 in the beginning there would no doubt be hard feelings among the partners. In this model the allocation is fair based on the personal choices of the two participants.

  Mike continues to spend time with his smokin’-hot girlfriend instead of building the business so they decide to add a third partner, Sam. Sam ran a bike shop for many years before selling it. His experience will add a lot to the business.

  Sam’s last salary at a bike shop was $50,000 per year. Sam agrees to the Grunt Model and starts work. Over the next month Mike spends 20 hours promoting the business, John spends 150 hours in the shop and Sam spends 50 hours in the shop and 50 hours calling his old customers and generating a lot of business

  Under the Grunt Model, Sam can slip right in and start earning pie. At $50,000 per year his GHRR is $50.00. John and Mike think this is fair given the fact that he has far more experience than either of them. At the end of the third month the pie split is as follows:

  The Grunt Fund has provided a method for adding another partner in a fair and consistent manner. The theoretical base value has grown and all parties have a fair share.

  Removing a Partner

  In the above example, it seems that Mike’s commitment is waning and he may be on his way out. At such an early stage, it would be impractical for Mike to keep his pie in spite of his contribution. Investors don’t look favorably on absentee-owners.

  While Mike has added value to the business and it should not be overlooked, it is clear that the young company has a long way to go and unless Mike sticks with it, he may not be entitled to the gains. There are three scenarios in which Mike can depart the business. Each one creates special circumstances that need to be considered if he is to be treated fairly. The three scenarios are:

  Mike can quit, also called resignation without cause

  Mike can be “pushed out”, also called resignation with good cause or termination without cause

  Mike can be fired, also called termination with cause

  Starting a new business is precarious and commitment of the partners is important. Half-hearted commitment can damage a business beyond repair. An understanding, in advance, of expectations can help pave the way to a successful transition without hard feelings.

  Resignation without Cause

  If Mike quits for personal reasons—resignation without cause—then he will have to accept a reduced slice of the pie and give the company the opportunity to buy it back. If the company cannot buy back the equity, the Grunt Fund after Mike’s departure looks like this:

  The Grunt Model has fairly resized the slices. Mike now receives $0 per hour worked instead of $20 and his cash contribution does not get the 4x multiplier.

  Notice that the total theoretical value of the pie has gone from $20,900 down to $14,500. This is not a problem. Remember, the company still has no actual value so this number is simply used to help define the relative size of the Grunts’ slices. It really doesn’t matter what the number is as long as it helps us keep track of the inputs.

  Both John and Sam now have a larger share of the pie. That doesn’t necessarily mean they are better off. They no longer have Mike and they may have to find someone new.

  Mike shouldn’t feel too bad. The company just wasn’t for him. He still has some pie, but the company can buy it back. It is important to remember that we are not dealing with actual stock with actual value. When I say “buyback” I’m really talking about the company paying back Mike’s cash. Remember, slices in the pie are nothing except a personal promise from the founder to provide an equity cut at some point in the future.

  If John, as the founder, does not want to give any pie to Mike he has several choices. The first is to blow off Mike and not keep his promise. This happens all the time, but it’s not fair.

  The other thing John could do is give $1,000 of his own money to pay back Mike for the expenses he incurred and the time he spent. John would then own Mike’s pie at the 4x rate.

  Or, if the company had $1,000 they could cut a check from the company account to cover the expenses.

  Mike should be happy with any of these deals. They are all fair.

  Termination without Cause or Resignation with Good Cause

  Let’s pretend that Mike liked working for the business, but couldn’t dedicate much time to the effort and his lack of dedication bothers John and Sam.

  John and Sam could simply ask h
im to leave. He did his job, he helped build the business, but they need someone more reliable. No hard feelings.

  In this case, it would be fair for the company to either do a buyout or allow Mike to keep his pie with a buyback option.

  If the company chooses to do a buyout, the Mike would be entitled to the theoretical value of his pie.

  Notice that this option is expensive. They will have to come up with $4,000 to pay back the $1,000 that Mike invested. This is perfectly fair. Mike didn’t actually do anything wrong, the other Grunts just wanted to replace him. It’s okay for them to want someone else, but they can’t penalize Mike for no reason.

  This kind of agreement creates a little job security for Grunts because herd members will need to think twice before they act on a whim and let someone go without cause.

  Likewise, if John and Sam told Mike that he wasn’t going to get paid as much (but they were keeping their rates), or if they told him that he was no longer in charge of marketing, Mike could resign for good reason with the same benefits as if he had been terminated without cause.

  Termination with Cause

  If Mike had been repeatedly asked to perform certain duties and he did not, John may have a cause to fire him. In this case it would count as a termination with cause and Mike would not be entitled to some of the pie.

  Mike would forfeit the pie earned through his hours worked as well as any unpaid commissions he would have received in pie.

  The cash Mike put in would be recalculated to match the actual value of the cash without the multiplier. The company does not have to pay this back, but will have to issue equity when the time comes. If the equity is issued then there should be a one-year protection as discussed before.

  John’s Bicycle Attic Survives

  As you can see, because John’s Bicycle Attic is using a Grunt Fund, the pie adjusts as the business changes and it is clear what happens under different scenarios.

  In all of the above scenarios, Mike is treated fairly. He gets what he deserves. Because he is a friend and fellow Grunt, he should be treated fairly no matter what.

  The Case of:

  PhoneMatcherator.com, LLC

  Sally was a successful businesswoman who made her fortune selling helicopters to other successful businesswomen and men. She also had a short stint as the CEO of an online company that sold cell phones during the dot-com bubble and did quite well. She had gone back into the helicopter business when she had an idea. The idea was to match people with the right cell phone after they answered a few questions. The idea wasn’t terribly original, but Sally thought it was and wanted to give it a shot.

  Sally put together a little PowerPoint outline of her idea and shared it with Frank, a career entrepreneur who had a lot of experience with online companies and, although he had started several tech companies, he hadn’t been as fortunate as Sally, who could retire if she wanted to.

  Frank, who didn’t have a big nest egg, told Sally he was interested in helping her start the company but he would need to earn a salary in addition to equity. Sally agreed and offered him $100,000 (which was half what he was paid in his previous position) plus 10% of the equity vesting over five years.

  She asked Frank to sign a complicated non-compete and non-disclosure agreement along with an employment agreement that provided severance payments and accelerated vesting of shares in the event that Frank was forced out of the company.

  Sally also took $100,000 in salary but agreed to let the money accrue instead of being paid. She often reminded the other staff members that she was not being paid current compensation-she mentioned this often in hopes of motivating them (it didn’t).

  Over the next few months Frank worked 60-70 hours per week and relocated his family so he could be closer to the office. Sally worked part-time on the business and invested about $250,000 of her own money. Frank brainstormed with Sally, wrote the business plan and the software specification, hired the staff, and began to execute.

  Sally spent thousands of dollars on lawyers and accountants who made sure all the contracts were neat and covered the appropriate asses, which, for the most part meant Sally’s ass. Rather than building a culture of trust, Sally built contracts.

  With Frank at the helm, the company successfully launched the site on time and within budget. Sally was very happy with Frank and gave him plenty of positive feedback and relied on him for most of the execution while she played more of a strategic role. They were a good team and built a good company.

  PhoneMatcherator.com grew steadily over the next two years and was meeting its projections; however, Sally grew frustrated that the company didn’t perform as well as the company she ran during the dot-com bubble. She didn’t realize that it was a different time and her company wasn’t the only company that sold phones online. Today there are hundreds of resellers.

  To make matters worse, a competitor had launched shortly after them and was growing neck-and-neck with PhoneMatcherator.com

  Sally was still selling helicopters on the side. She began to worry that the company wouldn’t be the overnight sensation that she had dreamed about and, on a whim, she terminated Frank without cause. Frank was shocked. He had received excellent feedback and had trusted her completely. She offered little explanation to her action other than she had “lost confidence” in his abilities.

  Under the terms of his employment agreement, Frank was entitled to severance payments and accelerated vesting of part of his equity. Sally held out on the severance payments and, taking advantage of a small loophole in the company’s operating agreement, she took back all the equity that Frank had earned over the past two years including the shares that vested under the employment agreement leaving Frank with nothing. After making Frank sign a broad and oppressive separation agreement, Sally paid him the severance payment that she owed.

  Over the next few months the company’s growth plateaued. They continued to burn through their startup fund and the other employees, who missed Frank, began to lose their passion for the business. After seeing how Sally treated Frank, a loyal employee, they began to look for other jobs fearing that they would meet the same fate.

  When Sally hired a new person, Sue, to replace Frank she made her sign a bunch of contracts. Sue found out that Sally hadn’t honored the contracts with Frank so she didn’t trust what she was signing. She and Sally had to create tighter contracts to eliminate loopholes. It was expensive and time consuming.

  By the time Sue got started the team had been hearing about all the legal work it took to get her on board and they resented her for spending so much time and money. They were fragile anyway. They also missed Frank which made Sue’s job even harder.

  The above example shows what can happen when entrepreneurs don’t use a Grunt Fund. Sally makes a number of important mistakes. The first mistake is that she didn’t fully understand the opportunity before jumping in. She figured that the company would explode in popularity just as her old company did during the dot-com boom. Sally is essentially a helicopter salesperson. She knows this and hires Frank to do most of the work.

  The next mistake Sally made was trying to slice the pie before it was baked. She carved off 10% and allocated it to Frank whom she hired on at half salary. Frank, seeing her wealth and past success, figured she knew what she was doing. Plus, she is a good salesperson and made Frank believe. It’s okay to get Grunts to believe, that’s the job. It’s not okay to take advantage of them.

  Sally, who also took a deferred salary, often brought up the sacrifice she was making to the other members of the team who were taking a salary. She thought they would work harder knowing how much she, herself, had on the line. However, because she had unfairly allocated the equity and kept the lion’s share for herself everyone thought she sounded like a total prick. After all, she had already accumulated enough wealth to retire and she was still in the helicopter business.

  Frank did his job, better than could be expected. He launched on time and hit the numbers. Sally was grateful to Fr
ank and told him so-this is good treatment of a good employee. However, Sally got cold feet. She drastically overestimated the market. Times have changed so despite Frank’s best efforts the company didn’t have a chance of performing up to Sally’s unrealistic expectations. She panicked and found, in Frank, a scapegoat.

  She burned Frank by reneging on her deal. She pulled the rug out from under him by not expressing her concerns earlier and giving him a chance to correct. He was doing what she had asked and working hard. He deserved more warning. Next, she took back the equity that he had earned fair and square. Because he was terminated without cause, Frank had no choice in the matter and should expect to keep what he earned. Sally, who doesn’t understand that pie grows, felt there was a finite amount of pie and that she needed to take it back so she could give it to her next victim. Otherwise she might have to give up hers (greed) or dilute the other participants, which would be fair in these circumstances.

  Lastly, she forced Frank into an oppressive non-compete. In the event of termination with cause or resignation without cause a non-compete is appropriate. Companies should not provide incentive for a person to leave and create or join a competing firm.

  However, in the case of resignation for good cause or termination without cause there should not be a non-compete. The individual has to find new work and they should not be hampered by a non-compete especially when the industry in which the company operates is likely to be the industry in which the person has the most contacts.

  If you decide to cut someone loose for no reason you have to be willing to accept the consequences of doing so. Like I said before, you can’t have your pie and eat it too. Non-competes are commonplace these days and largely unenforceable. However, just because companies use them doesn’t make them right. They are only fair in certain circumstances.