Fair Market Value
Slicing Pie uses fair market value as part of the formula for determining the perfect allocation of equity in a startup company.
The fair market value is the price that a given property, asset or service would fetch in the marketplace, subject to the following conditions:
- Prospective buyers and sellers are reasonably knowledgeable about the asset; they are behaving in their own best interests and are free of undue pressure to trade.
- A reasonable time period is given for the transaction to be completed.
Given these conditions, an asset’s fair market value should represent an accurate valuation or assessment of its worth and can be used in the Slicing Pie model.
Fair market value is the price a person would have been paid by someone who could afford to pay for the same contribution, this is similar to opportunity cost. When someone contributes something of value to a starting company they are, in effect, betting the fair market value of the contribution on the future outcome of the company. It’ a risky bet, which is why Slicing Pie uses a risk multiplier to calculate the number of slices.
Everything has a fair market value…as long as there is actually a market for the product or service and the individual in possession of the product or services has the wherewithal to reach that market.
The worms in my yard may have value to someone, but I, personally, have no access to the worm market so my contribution of worms is more or less valueless. The time I spent digging them up has the fair market value of a landscaper’s rate with similar skills to my own. If, however, I am a professional worm farmer and actively deal in worms, my worms have a fair market value.
The fair market value, therefore, lies at the intersection of the product or service being offered and the market to which it is being offered. A snow shovel has little or no value in Hawaii, but great value in Minnesota.
If I’m a computer programmer in San Francisco my fair market value may be much higher than someone with the exact same skills in Bangladesh.
If I am a highly skilled commodities trader in a town with no commodities exchange my skills have little or no value. In order to create value from my skills I need to move somewhere that I can apply my skills. I need to go where there is a demand for my skills. If, however, I’m joining a startup commodities exchange my skills may be applicable. My fair market rate would be whatever a person with my skills would get paid for my skills on the open market. In the case of a commodities trader, I might get paid a moderate base salary plus a percentage of the money I make for my employer.
Most of the time fair market value is easy to observe in the market place. It’s much easier and more reliable than trying to predict the future. If you can’t observe a fair market value there may be no market for the contribution and, therefore, no fair market value.
More details on how to determine fair market value for different kinds of contributions can be found in the Slicing Pie Handbook.
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[…] Pie uses fair market value as part of the formula for determining fair equity. I often get questions on how to value a […]
What do you do with a teammate who is one of the very best in his field and his Fair Market Value is very high hourly. However he’d also like to help the company in other areas and we both agree the hourly should not be so high for that other work.
It’s okay to have two rates, but usually not practical. In Slicing Pie, I recommend a cap at $200/hour in theoretical value (also equals 200 slices/hr). This equates to a $200,000 a year fair market salary. In my experience, people at this salary and above rarely drop everything and work full-time for a bootstrapped startup unless they are the founder or co-founder. They may join a funded startup, but not a bootstrapped startup.
If he is keeping his high salary, but wants to participate ask him to cap his rate and use the same rate for whatever he does. You want everyone to make the most of their talents so any time spent on lesser activities could probably be done by someone else.
So is there a way to have 2 rates for one person on your software? Our issue is he does recognize the value of our company and wants to be even more involved than the amazing skillset we originally hired him for.
While on the subject i’m looking for a way to change wages retroactively or per entry or type of entry. Something along those lines.
Hi Scott,
You would have to set up two different accounts for him and he would have to login as one or the other.
The software does not change salaries retroactively. That can be done through a special request from customer service.
-Mike
[…] while, someone will ask me why the Slicing Pie model isn’t based on value creation instead of the fair market value of the contribution made. The reasoning is logical: shouldn’t a person who creates the value reap […]
Hello Mike, do you think it is possible to slice only a part of the pie? Since I have previous agreements done with a partner and an investor, before even being aware of this Slicing Pie possibility?!!
Hi Rodrigo,
Yes, you can, but it’s not really fair. It may allow your partner and investor to maintain a larger share, but they would be doing so at the expense of other partners and investors. Most people want to be fair, so I would expect both of them to be willing to adapt. Once they understand the model they should see that it’s in the best interest of the company to use Slicing Pie.
You can adjust the split with the retrofit tool: http://slicingpie.com/slicing-pie-retrofitforecast-guide/
In my experience there are two reasons why someone would not want to use Slicing Pie. The first is that they don’t fully understand it in which case they need to read the books and the blog or set up a call with me.
The other reason is that they do understand it, but don’t mind taking advantage of others. If you are teamed up with someone like this it’s too bad and you’ll have to work around them. It starts with clarifying your current deal.
If someone has 10%, for instance, when does he or she dilute? When you bring on a new person? When you raise additional funds? When you reach Series A? Depending on your deal, you can introduce Slicing Pie at different times.
For example, if your deal is 10% at Series A you can use Slicing Pie for the Pie until Series A and simply carve out a chunk for the investor. If your deal is 10% of the current equity you can allocate 10% of the slices to that person at time of the grant and use Slicing Pie going forward from there.
Early equity deals cause problems. As long as everyone understands the benefits of fairness, Slicing Pie can help you unwind the issues.
This price never changes so long as you own the asset. On the other hand, market value is the current price at which you can sell an asset. For example, if you bought a house 10 years ago for $300,000, its book value for your entire period of ownership will remain $300,000. Read: Book Value vs Market Value
It’s not the value of the asset that matters, it’s the cost to acquire that matters. If I buy a house for $100,000 for the company, and it’s value goes up to $300,000, my expense (bet) is still $100,000.