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.