by Mike Moyer
You may want to include some vesting or options program to help retain people, but make sure everyone who has earned pie is treated the same. It’s not fair for you to change the rules on individual people. You can sometimes change the rules for the whole herd, but don’t single anyone out. New employees can have a different deal. Keep in mind that if you later raise outside capital the new investors may put your equity in a vesting program even if it has already been issued.
Grunt Funds are best for early-stage companies that haven’t built real value. By the time you actually do build value your team will be more or less solidified and new team members aren’t really “founders” anymore so they can be offered an option program or a salary. You can then “freeze” the fund in preparation for the next phase of the business.
Your attorney will find it much easier to put together your agreements once the business is up and running with a bright future and a cohesive team. Equity splits won’t be arbitrary, they will reflect real contributions.
Pie A La Mode
Grunt Fund-Friendly Lawyers
To find a Grunt Fund-friendly lawyer visit SlicingPie.com and click Pie à la Mode or scan the code.
Be sure to buy your lawyer a copy of Slicing Pie so they can create agreements that reflect the moral intent of the program. A good agreement will help guide good intentions. A bad agreement is a butt-covering tool that will allow mean people to take advantage of nice people.
Grunt Funds aren’t for mean people.
Cash Investment
When you receive a significant investment all the Grunts will accept formal equity allocations based on the relative sizes of their slices of the pie. In some cases the investor will require the equity to be awarded in the form of options rather than straight equity. This is better for a number of reasons and worse for a number of reasons that I won’t cover here. Just know that it is quite common for a formal investor to implement an option and/or vesting program.
Sometimes investors will impose some oppressive terms that seem unfair. The leader Grunt and other senior level Grunts will have to determine if it’s worth it. Sometimes the company is desperate enough to have to take less-than-perfect investors. The important thing is that all Grunts get treated the same under the new investor terms.
You may be wondering how large the investment has to be to warrant legal and financial formalities.
The answer is one million dollars.
Rarely will you ever receive such a straight answer to a question like this in the startup world. I, however, hate using the word “depends” so my answer is one million dollars. A million dollars isn’t a huge amount of money, but it does set an actual value for the company and it does make incremental Grunt hours from employees a little less meaningful.
If your company receives a cash investment of at least one million dollars it is time to call in the lawyers and accountants and get everything documented and formalized. You will need to update your articles of incorporation, rewrite your operating agreement, prepare your investment documents and, in some cases, create employment agreements for Grunts who are about to become employees.
Don’t be surprised if an investor who is bringing less than one million dollars to the table wants these things too. When this happens you will have to decide if it is worth it. The lawyers and accountants who do this kind of thing will charge you somewhere in the neighborhood of $15,000 - $50,000 for a very bare bones package. I would rather use that kind of money to get customers, but I completely understand if an investor wants to have the right agreements in place. Investors want to protect their money because it’s hard to get and everybody wants some.
If the money is coming in at less than one million dollars it might be easier to call it a convertible loan and be done with it. That way the cash can turn into equity when you do get someone willing to pony up a cool million or more. To provide security to the investor the key Grunts can personally guarantee the loan.
The amount of equity that the one million dollars buys will be based on the negotiated pre-money value, or what I call the “Magic Number”. It is the value that is high enough to motivate the Grunts to keep working and low enough to motivate the investor to invest. If the Magic Number is higher than the theoretical value of the contribution by the various Grunts everyone should be happy!
If your Magic Number is too low you and the other Grunts won’t walk away from the transaction with very much equity and your motivation will dip. If your Magic Number is too high the investors will look elsewhere for a better deal. Unfortunately for you, there is no shortage of potential deals for investors.
You don’t have to bring up the Grunt Fund and the TBV with potential investors. It has no bearing on actual value, so discussing it will only complicate things. At this point in the game you want to get the best deal for you and your fellow Grunts. When the investor comes on board they will be your team member so be sure to be fair in your dealings with them as well.
In the scheme of things one million dollars isn’t really that much money. How much of the pie the Grunts are able to share depends on how good they are a demonstrating value.
When you are starting to talk about real money your lawyer-dollars will be well spent. Lawyers and accountants will save you from a lot of headaches down the road now that you have actually baked a tasty pie!
Chapter Seven:
Grunt Fund Recap
The most common mistakes entrepreneurs make when allocating equity is slicing the pie before it is baked or slicing the pie after is it baked. Neither way takes into account the ever-changing needs of a fledgling business.
To make matters worse, most people use a fixed-split method for equity which inevitably leads to uncomfortable renegotiations when the company changes.
A Grunt Fund is a fair and equitable way to allocate equity in an early-stage startup company. It is a method for implementing a dynamic equity split for you and your fellow Grunts.
To employ the method simply track the theoretical value of the various ingredients that Grunts contribute in order to bake the pie.
Ingredients include:
Time
Money, in the form of cash or cash equivalents
Supplies and equipment that enable the business
Relationships
Intellectual property
In a Grunt Fund, Grunts are given pie in proportion to their contribution to the overall theoretical value.
Occasionally early Grunts can “harvest” some of the value they have created by calibrating the theoretical value to a higher number. The new value becomes the base against which they (and new Grunts entering the herd) will earn additional pie.
Care must be taken to ensure that the new, calibrated amount does not over estimate what the actual value of the company will eventually be. If it does, the Grunts will be unhappy.
As an alternative to calibration, the Grunts can “partition” off part of the pie and split up the rest. Their partitioned percentage remains fixed while the rest changes based on inputs from the herd.
When a Grunt resigns without cause or is terminated with cause they should not expect to get any pie at the theoretical value of their contributions. At best, they should be entitled to a slice based on an adjusted value that is set equal to the actual value of cash or cash equivalents. The company should be able to maintain a buyback option for the pie.
When a Grunt resigns with good cause, is terminated without cause, becomes disabled, or dies, the Grunt should expect to keep their slice of the pie at the theoretical value less any severance payments.
The company can choose to maintain a buyback provision at an amount equal to the theoretical value or the fair value, whichever is higher. The buyback should provide full value of the shares if there is a significant liquidation event within one year of the buyback.
A Grunt Fund, at its core, is about treating people fairly. While most entrepreneurs are motivated by money at some level, they are also motivated by being part of
the game, working as a team and building something from scratch. Being a Grunt takes dedication and commitment. It’s a hard life but the rewards are great—even if the company isn’t successful. The evidence is that many Grunts jump right back in to startups after leaving failed startups. They can’t get enough.
It is possible, and indeed common, for entrepreneurs to bite the hand that feeds them by burning hardworking Grunts. Sometimes this is intentional and sometimes it’s because they lack the tools and the understanding to execute a fair model—now they have one.
If you bake it, they will come…
Chapter Eight:
Retrofitting a Grunt Fund
If you have already launched your business chances are good that you have already implemented a fixed split that is causing some angst among the founders. You now need to unwind your fixed split so you can get on the right track with your equity. This will require you to retrofit the Grunt Fund. Retrofitting a Grunt Fund is fairly easy as long as everyone is willing to cooperate.
Getting Buy-In from the Herd
The first thing you will need to do is get everyone on board with the program by helping them see the benefit of a dynamic equity split program. To do this, just give them a copy of this book.
The people on your team will fall into two categories:
“Skinny Grunts” are those who have less than they deserve
“Fat Grunts” are those who have more than they deserve
(It is unlikely that anyone will have exactly what they deserve.)
The Skinny Grunts will be easy to convince. They already feel cheated by the Fat Grunts and, as much as they might like the business and believe in the vision, their motivation is probably waning because they feel like they are working for someone else’s benefit.
The Fat Grunts may be harder to convince because after the retrofit they will probably have a smaller portion of equity and they will have to start working to maintain or grow their position in the company. This, of course, is completely fair.
In most cases, if they have this book, they should be on board by the time they read this section. If not, I have a message for them:
Dear Fat Grunt,
Your current share of the equity that you hold in this business is disproportionate to what you actually deserve and it is now threatening your relationships with other team members and probably destroying the company. The company will be more valuable if you realign your interests with the rest of the team. Unless you are willing to be fair about what you and everyone deserves you will limit the chances that your company will be successful and that shares will ever be worth anything. Please cooperate with the rest of your team to ensure that you and your fellow Grunts get the right amount of equity.
Most sincerely,
Mike Moyer, Grunt
If that doesn’t work, you are probably dealing with someone who has trust or greed issues. Either way they are not properly aligned with the team. This is a good time to fire them.
You need to work with people that you can trust. You can’t trust people who aren’t willing to treat you and the other members of the team fairly. A greedy Fat Grunt is someone who is comfortable benefiting at the expense of others. There is a word for people like this; the word is “asshole.” It’s is best not to do business with assholes. You can probably find someone else to do that Grunt’s job
Some Grunts, like those who have controlling interest in the company, own the core intellectual property or have large amounts of cash invested, are difficult to replace.
If you are dealing with an irreplaceable Grunt you may have to cut your losses and leave the company yourself. There are greener pastures for a good Grunt.
Such are the problems with fixed-split equity program. Next time you will be older and wiser and can start a Grunt Fund from the beginning. I hope you will not have this problem.
The Retrofit
Once you get everyone on board with the program you will have to calculate what the pie would have looked like if you had been using a Grunt Fund from day one. This will require you to do an inventory of the various contributions that people have made and add it all up to determine your TBV. Time will be the most difficult because in most cases people will not have been tracking their time very accurately.
Time Tracking
At this point it will be impractical for everyone to remember how many hours they contributed. It will be easier to divide people into full-time, half-time and part-time.
Count the number of weeks people have been involved and use 40-50 hours per week for full time employees, 20 hours per week for half time employees and 10 hours per week for part time employees. Do your best, but don’t split hairs—it’s not worth it.
The Pie
Once you figure out what the pie should look like all of the participants in the Grunt Fund will simply continue earning pie according to the regular rules. Things will proceed as described in this book. At some point you will outgrow the Grunt Fund and you will want to issue actual stock and work with your lawyer to put the right agreements in place.
When you issue stock (in an LLC they may be called “participation shares” or “units” or something like that) you simply issue enough shares to bring everyone to the right percentages.
Example:
Grunt 1 and Grunt 2 start a company together and split the equity “50/50” they authorize 100 shares in the company and each take 50 shares.
A few months go by and it becomes obvious that Grunt 1 isn’t very interested in the business. They agree to retrofit a Grunt Fund to solve the problem.
They go back and tally up each of their contributions since the beginning and determine that if they had been using a Grunt Fund from day one Grunt 1 would have about 25% of the pie and Grunt 2 would have 75% of the pie. (At this point it doesn’t really matter what stock has been issued because the stock is worthless anyway.) From that point on they earn pie under the terms of the Grunt Fund.
When Grunt 3 joins the herd she starts earning pie under the terms of the Grunt Fund. Simple as pie.
Six months go by and the team is getting some traction in the market. They are generating some nice revenue and they have outgrown the Grunt Fund. Grunt 1 has about 30% of the pie, Grunt 2 has 60% of the pie and Grunt 3 has 10% of the pie. They decide to issue 69 shares of stock to allocate the proper percentages.
Remember, Grunts 1 and 2 already each have 50 shares. So, Grunt 1 gets zero new shares, Grunt 2 gets 52 shares and Grunt 3 (who had zero) gets 17 shares. When the new stock is granted the ownership looks like this:
The Grunt Fund has properly allocated shares to the right people. Each Grunt has a share that is fair relative to the other Grunts. The original allocations had no impact on the outcome because the additional stock grants balanced things out appropriately.
Grunt 2, who originally owned 50% of the company now owns 30%. He has nothing to be sad about; the company is now worth much more than before. If he had decided to be an Asshole the company probably would have fallen apart.
A Note about Fat Grunts
Not all Fat Grunts are assholes. In some cases a Grunt is intentionally fat because they used the partitioning or calibration technique I mentioned before. This is fine as long as all the other Grunts are aware of the situation.
These techniques allow very early founders to benefit from their early work in the company. As long as they are playing by the rules, all is fair and square.
Chapter Nine:
Going Out of Business
There are two main reasons why an early stage startup fails. The first is that the company goes bankrupt because it can’t meet its financial obligations. The second is that the founders learn enough about the market to decide that it’s not really as cool as they initially thought.
Bankruptcy
Sometimes your fledgling company will rack up some serious debt and, before you know it, you are all underwater. Unless your company is generating enough cash to service the debt you will need a way to c
ome up with payments.
As I mentioned before, when a Grunt personally secures debt on behalf of the company it will not translate into pie so long as the debt is being serviced by the company. However, if the company cannot cover payments, the individual who guaranteed the credit is now responsible for covering the payment him or herself. In these cases the payments are treated as cash contributions for which the theoretical value is four times the amount of the payment (which doesn’t matter much if the company is going under but oh well…)
Usually the debt is taken on by a senior participant. Rarely, if ever, should the company use credit supplied by a junior member of the team.
If the company has secured the credit on its own and cannot cover the payments, it must look for cash contributions. In some cases, members of the herd can come to the rescue. In other cases you can invite an outside investor. Unfortunately, outside investors rarely want to bail a startup company out of debt. This is a pretty bad use of funds.
It would be tempting to “pass the hat” or allocate the debt across participants according to their share of equity. This is a bad idea. Grunts don’t want to be put in a position where they have to cough up their own money. They work for pie. Pie will become equity. Equity is an asset. Grunts do not work for liabilities. If they think their job is turning into a liability they will resign.