Should Your Start-up Consider an Innovative Equity Model?
Choosing the right structure and equity allocation for a new venture can create stress for a lot of entrepreneurs. Unfortunately, the equity issue usually comes at a time when there are many other things that the founders are dealing with. Disparity in finances, hours being put in, connections, and any other possible resources can create problems when people are trying to decide how to divide their start-up and allocate equity. Slicing pie, a concept by Mike Moyer, aims to solve this initial hurdle entrepreneurs often face in his book, The Slicing Pie Handbook: Perfectly Fair Equity Splits for Bootstrapped Start-ups.
Moyer teaches Entrepreneurship at Northwestern University and the University of Chicago Booth School of Business. He is a staunch advocate of slicing pie, enthusiastically pointing out all of the problems it can solve and the opportunities it may create. However, solutions to the problems within slicing pie itself are much less plentiful and without an exuberant spokesperson.
The slicing pie concept itself is fairly simple. Implementing it in Canada however, as opposed to the United States where slicing pie originated, is a lot more uncertain and complicated.
The idea is that everyone is compensated for their specific contributions to the company. This means that when someone invests with time, money, ideas, relationships, supplies, equipment, facilities or anything else someone provides without full payment that they are then allocated ‘slices’ of the pie. The pie represents the company, and the slices are a proxy for the individual shares of each person who the pie is split among. The model is dynamic because it adjusts every day as the contributions are made by those working on business. The idea is that if you contributed on a given day, your piece of the pie should reflect that immediately.
The formula is an individual’s % share = individual's Slices ÷ all Slices. This applies until the company starts to break even or they raise enough capital to pay the equity holders for their contributions. When one of these events happens, the pie would ‘bake’ or the split would be frozen and the allocation at that time would determine the distribution of dividends or proceeds of a sale.
The reason for slices and not shares in the traditional sense is the defence mechanisms the concept has built in. With equity, if someone were to leave the company, they maintain that equity. With slices of pie, the idea is that anyone who leaves would be forfeiting their contributions. This is billed as an advantage of slicing pie because it is supposed to keep people committed and bought in to the business’ success for a longer period of time.
However, Canadian courts may not uphold this type of arrangement. In Canada, the principle of equitable relief, such as that referenced in section 16 of the Alberta Judicature Act, means that courts may find anyone who left a company with slices, and not shares, is entitled to the value of those slices anyways. Since the solution slicing pie is offering is to essentially force someone to give up all contributions they have made to a company if they do what is within their rights to do and leave, it is quite logical to think courts will deem that to be unfair. If the courts felt it was unconscionable for the person leaving to receive nothing from their work, it could fundamentally eliminate one of the reasons to use slicing pie.
At this point there is not case law in Canada dealing with the issues slicing pie presents for Canadian law so we cannot be certain as to how the common law and equity would handle a slicing pie dispute. The important thing is that it is a potential issue, and one which is not mentioned or addressed by the very limited slicing pie literature. As time passes and the model is not so new, hopefully there will be answers from the courts and from the relevant tax authorities on how the slicing pie model will be treated.
Another issue with the legally absent equity allocation slicing pie temporarily creates is that the division of the pie may not be honoured. When it comes time to bake the pie, there isn’t a guarantee that everyone will get the share they had with the slices. Everyone involved must trust each other that they will get what they were supposed to. This leads to the second potential issue. Slicing pie claims that because there is no formalized equity until an event that bakes the pie, and therefore terminates the model, there are no potential tax consequences. If one were to try to get around the risk of someone not honoring the slicing pie arrangement by legal agreement, they would be defeating the whole purpose of the model by effectively setting an equity arrangement. This could possibly catch the attention of the Canadian Revenue Agency which may determine equity was held much earlier on, before the pie was officially baked, than claimed.
Slicing pie also theorizes that it will incentivize people into staying committed to the business longer. However, since the slices convert to equity once the company sees success, someone could simply wait until that event and then leave. Alternatively, if the company never returns value then the equity they gave up by leaving had no value anyways, rendering the threat slicing pie implies empty. In the meantime, if they are truly disinterested in the company, they have no reason to contribute more to the pie. They may not officially break off the relationship but could for all intents and purposes stopped adding value of any kind. To think someone that would otherwise leave a venture will stay and work hard for that business’ success because of slicing pie seems to be an untested and flawed theory.
While the slicing pie model advertises that it solves the issue of conflict during equity allocation, and it very well might, it may also just shift the problem. Similar to competing interests wanting different equity decision, there still needs to be negotiation and agreement about what contributions result in slices. For example, one party may have more financial resources while the other has much more time to put into the business. How to properly weight cash contributions compared to an hour of someone’s time must still be agreed upon. In a sense, slicing pie may just be shifting around where the difficult negotiations points exist.
Unfortunately, as with most things slicing pie in Canada, there is a lack of information or certainty. Since the theory was formed by Mike Moyer, and the information on it is contained on his slicing pie website (https://slicingpie.com/) and in his books, there is a deficit of objective and critical information dealing with the challenges the model may face. This is especially true for jurisdictions that are not the United States.
While slicing pie is an exciting and innovative model for helping start-ups deal with equity distribution, there are still many unknowns. Anyone considering the model should take careful consideration of the potential tax and legal uncertainty while also thinking about whether the model will add value to the business or if it will cause as many issues as it solves.
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.