How does The Slicing Pie Model of equity distribution deal with 409(a) valuation issues, when measuring contributed value by the value of time contributions?
Thanks for asking about Slicing Pie. A 409A would officially price the value of the company and, therefore, be used after the Pie "bakes". Slicing Pie is used during the bootstrapping stage of the company before the company can be realistically valued.
I have a blog post that provides an overview of funding options for Slicing Pie (or any other) companies: http://slicingpie.com/paying-for-the-pie/
The key thing to remember about Slicing Pie is that it solves 100% of the problems associated with conventional fixed splits. Whenever you have a question you can reach out to me through SlicingPie.com. I have yet to find an equity issue for early-stage companies that Slicing Pie doesn't solve!
1. Phantom Taxable Income / Property transferred in connection with performance of services. It would seem that valuing contributions based on time and effort are likely to generate a fair amount of phantom taxable income without the use of a proper 409A valuation process, and even with the use of a proper 409A valuation process. (See generally 26 U.S. Code § 83 - Property transferred in connection with performance of services)
2. Securities Law. Also if the affected "co-founders" are not true founders (that is they are not true Principals) are there not securities law (Howey Test) compliance issues that must be addressed with multiple issuances of equity to such "co-founders". A true Principal is a person who assigns tasks, determines if performance is adequate, and hires and fires.... and is someone who is not themselves subject to being fired.
3. Moral Hazard. There is potential moral hazard to those participants who are not the Principal(s) and who can be subjected to unreasonable effort/reward schedules, phantom tax risk, and arbitrary termination (actual or de facto) by Principal(s). What are the common methods that people are currently using to deal with it? Employment agreements? Buyout agreements? Just trusting and going naked? Or what?
4. Background Details. I never see anyone talking about these details. Are there any links out there that address them in the context of implementing the Slicing Pie Model of equity distribution?
Thanks for your response.
I agree with you that the problem of equity splitting is a real problem and that cutting the pie is an innovative solution to the problem, it is just that all the material I have seen so far on it, seems to disregard or minimize some real issues that should not be disregarded. (See my prior posting here)
I went here:
I didn't find the legal component of the content to be very satisfying. Much needs to be addressed (or at least warned about) that is not there.
And I have to take great exception to at least one paragraph I found there: "Slicing Pie allows a company to divide equity in a company before a valuation can be set. Until a value can be set, the value is $0. If nobody is willing to buy it (your equity) it has no value. Think about it, what the value of a product that nobody wants? So, unless the company is raising a serious amount of money with professional investors you should probably be slicing Pie instead of pricing Pie."
I would encourage you to consider having one of your slicing pie lawyers write a chapter in your book addressing these issues at least briefly in order to ensure that people understand some of these issues from a legal perspective.
And again, I think your slicing pie approach is an innovative solution to a real problem. In fact I like the approach and it will probably inform what I do in the future.
I just think there are some extra moving parts that people should be better apprised of before implementing the approach... and once apprised will affect how they implement it. (nothing secret, see my prior posting outlining them)