Slicing Pie: Fund Your Company Without Funds

by Mike Moyer

  No matter what you do you are all eventually going to run into a situation where you have percentages of percentages and it will get harder to get your head around it. This is sort of unavoidable so brace yourself!

  Outgrowing the Grunt Fund

  When your company gets big enough you will outgrow your Grunt Fund. Mostly because your incremental percentage of pie gets smaller as time goes by. In the beginning your 10 hours of work may be equal to 50% of the company if your partner also works 10 hours. Later, when the company has a $500,000 TBV your 10 hours won’t get you very much. By this time you are probably ready to start looking for real investors. When you get the cash you can hire a lawyer and an accountant to put together a nice option program.

  When you sit down with your lawyer you can tell them exactly how many shares each person on the team should receive. Remember, the TBV has no bearing on the value of your company. It simply provided a means to calculate percentages.

  Chapter Five:

  Subtracting a Grunt

  Few events take their toll on a startup company more than when a Grunt leaves. It is highly disruptive. Sometimes they are no longer interested in the project or no longer share the vision. Other times they have other obligations, such as family, that forces them back into day jobs and sometimes the Grunt isn’t a good fit with the herd and has to be asked to leave.

  When a Grunt leaves the herd, either by choice or by force, great care must be taken to treat the Grunt fairly. Even if the Grunt is being fired for being a total jerk there is still proper and fair treatment. If, as the herd’s leader, you treat a departing Grunt unfairly, you will do damage to the entire herd. The last thing you want is a herd of disgruntled Grunts.

  Besides treating a Grunt with dignity and respect, fair treatment includes how much pie a departing Grunt is or is not entitled to as well as what the company is entitled to in terms of pie buyback or non-competition. When a Grunt leaves and keeps his or her pie they will become an absentee owner which, as mentioned before, is something to avoid if possible and fair.

  Determining who is entitled to what will depend largely on the circumstances of their departure. There are three main reasons a Grunt will leave the herd:

  They might resign

  They might be fired

  They may no longer be able to work because they become disabled or dead

  Resignation

  When a Grunt resigns, or quits, the motivation to do so falls into two buckets. The first bucket is called “resignation without cause” the second is called “resignation with good cause”.

  Resignation Without Cause

  Sometimes a Grunt loses interest in the company or sometimes they have external pressures that prevent them from being able to contribute to the company in a meaningful way.

  So, the Grunt resigns. In the case of resignation without cause, the Grunt has broken its commitment to the company and should not expect to retain the same slice of the pie as they would have as an employee. It’s a free country and there is no reason why a Grunt can’t move on to what they feel are greener pastures. But, you can’t have your pie and eat it too!

  When a Grunt resigns without cause, they will forfeit all of the pie earned in the Grunt Fund through the time they contributed to the company.

  Next, the company should recalculate the theoretical value of the Grunt’s other contributions without the multipliers. The new theoretical value becomes the value of what the company would have paid for supplies and equipment (if they could have) and the actual value of the cash.

  This may sound a little harsh, but by agreeing in advance to reduce the theoretical value of a Grunt’s inputs, you are creating an incentive not to leave. Retaining employees is important and a Grunt Fund has this built-in retention program.

  Additionally, the company should reserve the right to buy back the pie at a price equal to the new theoretical value.

  If possible, pay back any cash contributions the Grunt has made especially if the Grunt is leaving for financial reasons. You may want the Grunt back for a future herd—treat all Grunts fairly.

  Leaving the herd in the lurch has consequences and it should. When a Grunt resigns and maintains its original slice of pie, the Company will have lost a piece of itself that they may need in order to provide incentive to a replacement Grunt.

  In the movie Startup.com, the president of a dot-com company has to negotiate a buyout of the stock owned by an early partner who had left the company. He wound up paying $800,000. Ouch. This was money that could have been put to better use than paying off a former employee who left on a whim! This guy, as it turns out, was pretty much the only guy who made any money off their stock!

  The other issue is non-competition. In the case of resignation without cause the company should secure a non-compete agreement in exchange for letting the Grunt keep the pie in the company. This will provide a deterrent to Grunts who want to take what they learned with you and start a competing business. Many states won’t support a non-compete, but some will. Make sure you have been clear that the Grunt was never promised any cash from the business.

  Even if you live in a state that won’t enforce the non-compete agreement ask them to sign it anyway. Just like the Grunt Fund is a moral contract, so is the non-compete. Sure, the Grunt can break his or her promise, but if they are a good person they should recognize that they were treated fairly. They should treat you fairly as well.

  By the way, the leaving Grunt does not get their stuff back if they brought anything. When a Grunt provides supplies and equipment it generally becomes property of the company. The same goes for ideas and intellectual property. If the Grunt holds a patent to the idea in their name they should have already given the company an exclusive right to the idea. In most cases, even if they are fired, Grunts entitled to royalty payments will continue to receive them at the Grunt Fund rate (unpaid royalty x 2).

  Sometimes a Grunt loses interest in the company

  When a Grunt leaves a company because they can’t afford to work with no income, and the company can’t afford to pay them, it may be appropriate to keep the Grunt as a part-time member of the herd and allow them to keep their pie. Don’t play hardball with Grunts if you don’t have to.

  Resignation With Good Cause

  Sometimes a Grunt is “pushed-out” of a company or compelled to leave because the other Grunts made decisions that changed the situation so much for the Grunt that it’s not what they originally signed up for.

  In some cases the decisions are unavoidable, in other cases the decision seemed more important than the negative impact it would have on the affected Grunt. Such decisions would include:

  Adverse change in title or responsibilities. If the Vice Grunt of Marketing was demoted to the Director of Operations, the Grunt would have a good cause to leave. They wouldn’t have to leave, but the role is clearly no longer what they signed up for.

  Adverse change in compensation that does not affect other participants at the same level. If the other Grunts cut the Grunt’s GHRR by 50% but the others’ GHRR stayed the same.

  Relocation of the company more than 50 miles from its original location. The Grunt may not be able to manage the commute. Extending the commute puts an unfair burden on the Grunt.

  Death or disability.

  Sometimes the company chooses to change their strategy or they take on a new Grunt that has a particular set of skills that make another Grunt redundant. Or, perhaps they just don’t like a Grunt even though the Grunt has worked hard and made a positive contribution. Companies, especially startup companies, change fast and that means the herd must adapt and change as well. When this happens, however, you must still act fairly when dealing with the departing Grunt.

  Whatever the reason, if the Grunt resigns with good cause, they should have an expectation of remuneration or pie that is more in line with their theoretical contribution.

  In these cases the Grunt should be able to maintain their pie minus the amount of any severance payme
nts made (if any). Subtract severance payments from their GHRR and recalculate the pie.

  The company can choose to maintain a buyback option that would allow them to buyback the pie at the theoretical value (unadjusted) or fair value, whichever is higher. The buyback option should have a one-year protection clause that allows the departing Grunt to receive the full value of the shares if the company sells or goes public within 365 days after the buyback occurs. This will prevent the company from buying back the pie at the last minute before a liquidation event to turn a quick profit at the expense of the Grunt.

  With regard to non-competition, the company is not entitled. The Grunt should be free to compete. If the company is concerned about this they should be more careful not to provide good cause for resignation. It’s important to note, however, that this does not mean the Grunt can steal ideas and intellectual property from the company, even if the ideas were theirs. It does mean, however, that they can join a company in the same industry. For instance, if your company makes soda pop the departing Grunt can join a competitive soda pop company, but they can’t take your secret formula, brands or other proprietary ideas.

  This is fair treatment for a departing Grunt who left for circumstances outside his or her control. It is not fair to penalize a Grunt when he dedicated his time, energy and resources in good faith to the company. While it may not be ideal to have an absentee owner, it is much better than burning the Grunt and risking damage to your relationships with other members of the herd.

  Death and Disability

  If a Grunt becomes disabled she should be treated as Grunts who resigned for good cause. If the Grunt dies, his family should receive the full benefit of his contribution to the firm and they should be treated with as much respect as the Grunt himself.

  Termination

  When it’s the company’s decision to fire a Grunt it is called termination. Like resignation, termination can be with or without cause.

  Termination Without Cause

  These days business must change and adapt quickly. It is the job of the management team to make sure the right Grunts are in the right places. From time to time, however, the strategy changes and good, hardworking Grunts are no longer needed.

  Several years ago I started a company and hired a staff of four to handle outbound telemarketing. I thought that telemarketing was the way to sell the product. It wasn’t. The telemarketing Grunts worked hard and did their job, but I had to let them go. The company changed its strategy and no longer needed a herd of telemarketing Grunts. It wasn’t their fault, it was mine.

  When you terminate a Grunt without cause they should be treated the same way as if they left for good cause. This means they can retain their slice of the pie and even compete with you if they want (again, however, they can’t take the company’s intellectual property). While it might be more convenient for you if the Grunt didn’t compete it wouldn’t be fair. If you are concerned about competition then you should find a way to keep them in the herd.

  Termination without cause must be handled extremely delicately. Nothing shows the true colors of a leader more than how they handle this situation.

  I once knew a startup where the CEO short-changed a Grunt who he terminated without cause. The Grunt had been faithful and had worked side-by-side with the CEO who had given him a lot of positive feedback for the Grunt’s work.

  However, the CEO was not a seasoned Grunt and he began to panic that the company wasn’t an overnight success. He woke up one day and decided to let the hardworking Grunt go for no apparent reason.

  The nasty CEO took back the equity the Grunt had vested by taking advantage of a loophole in the operating agreement even though it was clearly against the spirit of the contract.

  Next, he withheld promised severance payments and slapped the Grunt with an oppressive non-compete agreement. The Grunt was mistreated and the other Grunts noticed. Morale sank, the company moved sideways for many months and they never got back on track.

  The other Grunts saw the true colors of the leader and they began to question whether they would someday be treated unfairly themselves.

  The CEO was unfair and selfish. He didn’t understand that pies grew and he let greed steer his thoughts. By mistreating a Grunt in this manner he sent a clear message to the other Grunts that he didn’t care about honoring the letter or the spirit of contracts and that he only cared about himself.

  There is nothing more important than fair treatment. At the end of the day, all the money in the world won’t make you a better person.

  Termination With Cause

  Sometimes the leader of the herd must fire a Grunt for cause. Generally speaking “cause” means one of the following:

  Serious misconduct such as theft, dishonesty or assault. Embezzlement, fighting, doing drugs or other illegal activity.

  Habitual neglect of duty or incompetence. For this to be cause, the participant has to clearly understand the requirements of the job, the requirements have to be reasonable given the resources of the company and a reasonable time period must be given for improvement.

  Conduct incompatible with the employee’s duties or prejudicial to the employer’s business. Engaging in activities during the workday that interfere with employment obligations or that compete with an employer’s business is generally considered “cause”. I once worked for an automotive company where one of the customer service people was ordering parts samples for his own use. Vendors would send them at no charge and the guy would take them home with him to put on his own car. This is unacceptable behavior. He was let go.

  Willful disobedience is another cause for termination. It means contempt or disrespect for individuals (especially superiors) or rules. It can also mean disobeying a reasonable and lawful request by the employer.

  If the Grunt is terminated for cause, she should be treated the same as if she had resigned without cause. The company should recalculate her slice of the pie without the multipliers and the company should get a buyback right. Additionally, she should be required to sign a non-compete agreement in exchange for keeping their slice. Of course, if the Grunt embezzled money or otherwise sabotaged the business you may have a different set of legal problems. Even in these cases, fair treatment will keep you out of trouble.

  How a manager handles termination for cause provides another peek into his or her true colors. Everyone in business should be treated with respect and dignity, no matter what.

  I recently had coffee with a friend of mine who saw a mismanaged termination in his company and how it soured the attitudes of the whole heard. The manager was never really trusted again. To make matters worse, the manager became defensive whenever the terminated team member was mentioned in a positive way exacerbating the situation. The company never fully recovered.

  Keep in mind that the company may have no legal obligation to anyone who leaves the company. But Slicing Pie isn’t about what someone can legally get away with, it’s about doing right by those who help you.

  When we look at the world through only the legal lens we often overlook what is the right moral choice. Pie isn’t equity, it’s a promise. Promises should be kept.

  For instance, the non-compete that you sign with a departing Grunt isn’t a formal legal agreement, it’s a reminder of the spirit of the Grunt Fund.

  The right decision may not always be the most convenient, but in the long run I believe the company will be better off. Just because you can get away with something legally doesn’t mean it’s right.

  Chapter Six:

  The Magic Number

  There are three situations in which you would want to stop using the Grunt Fund.

  When you have built up so much theoretical value that you have reached a point of diminishing returns.

  You have started to build an actual business model with predictable returns

  The company receives a cash investment that is large enough to warrant legal and financial formalities.

  The Point of Diminishing Returns
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  In the beginning a few hours of work might earn a significant slice of the pie. $100 in contributions against a $900 TBV would earn 10% of the pie. However, if your TBV is $500,000 then your $100 incremental slice isn’t much. This would be a good time to convert the pie to real equity.

  Participants are no longer motivated by the incremental pie and new incentive program can be developed. Additionally, by the time this much work has gone into the pie you will know who the dedicated and valuable players are likely to be.

  An Actual Business

  Not all companies need to take on outside money. You may be smart or lucky enough to figure out how to grow your business based on revenues. In these cases the right time to stop using the Grunt Fund is when you have developed a predictable business model that looks like it’s going to be a winner.

  “Predictable” means that you have a revenue stream in the foreseeable future, you understand your basic cost structure and you have a plan for growth.

  When you have this, you have a business that may have built actual value and you will need to hammer out the equity details more formally. This means calling your attorney, telling him or her how much pie everyone gets and asking them to put together an Operating Agreement or Shareholder’s Agreement that will allow you to continue with your current team.