Tips for Lawyers for Implementing Slicing Pie

Tips for Lawyers for Implementing Slicing Pie

The goal of Slicing Pie is to create a fair split and it is used by startup companies all over the world to do just that.

As a lawyer, you may not have heard of the Slicing Pie model or maybe you have, and you are skeptical. I have been working with lawyers and startups to implement Slicing Pie for years and I can personally attest that it works 100% of the time and requires no customization or tweaking to yield fair results. Changes can only make it less fair.

Unlike traditional equity splits which require the team to decide fixed percentages upfront for each participant in anticipation of future contributions, Slicing Pie divides up equity based on what each person actually contributes. Because Slicing Pie is based on observable facts, instead of guesses about future events, it always creates a fair split.

To implement Slicing Pie from a legal standpoint it’s important to understand a few key concepts:

  1. Slicing Pie is “dynamic” as opposed to traditional splits that are “fixed.” This means that it self-adjusts over time as the company develops. The actual changes to equity do not have to be dynamic, they can happen all at once when the Pie “bakes” or terminates. While this may seem uncomfortable for some people, it ensures that people get what they deserve based on their actions instead of their intentions.
  2. All equity splits change over time as a company develops. The rationale behind the changes is often flawed, yet the changes happen anyway. Slicing Pie simply provides decision-making logic for making the changes. In other words, there is nothing new going on with Slicing Pie, people are just making better decisions than they would without Slicing Pie.
  3. Slicing Pie is used during the bootstrapping stage of the startup’s lifecycle, when equity is essentially valueless, and it ends at breakeven or Series A investment, when the equity can be reliably priced. It is for this reason that there should not be any tax consequences when using Slicing Pie.
  4. After Slicing Pie terminates, the share price and the terms of the Series A investor (or other valuation event) will apply going forward.
  5. I am more than happy to meet with you or your client at any time to discuss the implementation of Slicing Pie. I can provide contract samples, spreadsheets, and other content at no charge. I want this to be easy so you can concentrate on legal matters other than corporate formation. I can be reached here..

Legal Implementation

I am not a lawyer (a fact that I often lament). And the laws in each country – particularly tax laws – are key to advising on and structuring how to formally implement the Slicing Pie model. However, I’ve worked with numerous lawyers all over the world, and find that they usually implement  the Slicing Pie model in one of two ways: either by doing a buy-back, or Slicing Pie vesting (which is different than time-based vesting). Both of these methods can work even if allocations of equity are required at the outset.

BUY-BACK METHOD

Step One: Issue common shares or membership units in equal chunks to each participant when they join the venture.

  • I suggest 10,000 shares each so when the adjustment is made you can avoid fractional shares.
  • At this point, ownership is meaningless because there is no financial benefit to the shares. The Pie will bake well before dividends are paid so there should not be a problem. Remember, Slicing Pie is used during the bootstrap stage when there is no profit[1]. Common shares generally have voting rights. If control is a concern, there are various ways this can be addressed, with co-founder rights, or by adding contractual voting.

Step Two: Stipulate in the stock purchase agreement that shares are subject to a buy-back option based on Slicing Pie. The buy-back price can be the original par value (or $0, if no money was paid for the shares and this is allowed under local law).

  • Slicing Pie terms can be included in the buy-back clause or the model can simply be referenced. Slicing Pie is fairly well known, and the Slicing Pie Handbook and accompanying spreadsheets and software provide a common set of calculations.
  • I wish I could create a universal contract for this, but my talents do not include drafting legal contracts. If you create a contract with Slicing Pie terms, be sure to cover:
    • The Allocation Framework describing cash and non-cash contributions and the formula used to derive the final split.             
      • ((2 x Individual’s Non-Cash) + (4 x Individual’s Cash)) / ((2 x Total Non-Cash) + (4 x Total Cash))
      • “Cash” means cash consumed (unreimbursed expenses), not cash invested
      • “Non-cash” means the unpaid portion of the fair market value
    • The recovery Framework, which determines the disposition of equity (slices) in the event of separation under various circumstances.
      • Termination for cause or resignation without cause: participant would lose rights to equity and unreimbursed expenses would be paid back, when and if possible, by the company.
      • Termination without cause or resignation with cause: participant would retain rights to equity and receive allocation upon termination of the Pie.
      • Definitions for termination and resignation events are fairly standard and more detail can be found in the Slicing Pie Handbook.
  • More detail can be found in The Slicing Pie Handbook and I would be happy to provide some sample agreement forms.

Step Three: Slicing Pie terminates (or “bakes”) when the Pie naturally stops accumulating slices. This happens when the company can adequately fund operations from revenues (breakeven) or Series A investment so there is no need for participants to continue working without being paid or reimbursed for expenses. When the Pie stops changing, the buyback is triggered. The company buys back a number of shares from each participant to match the Slicing Pie allocation.

Simple Example

Two partners, Dick and Jane, each take 10,000 shares at the outset of the venture. When the Pie bakes it shows a fair allocation of Dick at 33.3% and Jane at 66.6%. In share terms there are a number of ways this split can be achieved. For example, Dick could sell back 5,000 shares and Jane could keep all 10,000. Now the shares are Dick at 5,000 (33.3%) and Jane at 10,000 (66.6%).

VESTING METHOD

Another method that I like is using Slicing Pie as the vesting mechanism as opposed to time-based vesting or milestone-based vesting. The process is very similar to the Buy-Back method above, except that instead of buying back excess shares you’re simply vesting the right number of shares.

Step One: Issue restricted shares or membership units in equal chunks to each participant when they join the venture. In the US, file an 83(b) election.

Step Two: Slicing Pie terminates (or “bakes”) when the Pie naturally stops accumulating slices. This happens when the company can adequately fund operations from revenues (breakeven) or Series A investment so there is no need for participants to continue working without being paid or reimbursed for expenses. When the Pie stops changing, the vesting is triggered. A number of shares from each participant vest to match the Slicing Pie allocation.

Simple Example

Two partners, Dick and Jane, each take 10,000 restricted shares at the outset of the venture. When the Pie bakes it shows a fair allocation of Dick at 33.3% and Jane at 66.6%. 5,000 of Dick’s shares would vest and all 10,000 of Jane’s shares would vest. Now the shares are Dick at 5,000 (33.3%) and Jane at 10,000 (66.6%). Theoretically, you could vest one share for Dick and two shares for Jane and the result would be the same.

Slicing Pie vs. Time-Based Vesting

With Slicing Pie, time-based vesting is irrelevant because the model provides all the protection needed in the case of separation.

Time-based vesting provides inadequate protection. For instance, a developer could quit out of the blue with an incomplete application and keep vested shares. With Slicing Pie, the developer would lose his or her slices and expenses would be reimbursed for expenses when the company has the money, a much more logical consequence.

Conclusion

I work with lawyers all over the world to implement Slicing Pie. Each country has its quirks that must be dealt with to implement Slicing Pie within a legal framework. I try to remind people that Slicing Pie, at its core, is a decision-making framework for how to allocate equity. All equity splits change over time as the startup evolves. How people decide to make those changes depends on how they make decisions. People can guess based on predictions about future events (aka the “Crystal Ball” method) or they can use Slicing Pie to make sure it’s fair. What this means is that no matter what legal structure you put in place, Slicing Pie can always be used to make decisions about changes.

As a decision-making model, Slicing Pie fundamentally changes how founders make equity allocation decisions, it does not fundamentally change how equity or business formation works! I encourage you to implement Slicing Pie as simply as you can, and stick to the model. Otherwise in my experience, fairness can start to break down.

Please do not hesitate to contact me through the Slicing Pie website (www.slicingpie.com) if you have any questions or concerns.


[1] I define profits as revenue minus expenses and salaries. For tax purposes classifying revenue minus expenses (not including salaries) as “profits” can be done for tax purposes. I don’t consider dividends and compensation the same thing. Dividends should be paid after salaries. You should, however, do what you can to manage taxes!

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