What is dynamic equity split?
The fairest and most flexible equity split for bootstrapped startups
Put simply – an equity split where the cofounders agree to adjust their equity share based on pre-agreed formula and for certain time.
It does address a lot of the inherent challenges of the fixed equity splits (How to get the equity split wrong) – mainly the main problem that at the beginning it is close to impossible to predict how much each of the cofounders will contribute to the business.
Two things you NEED to KNOW as you start with the not-the-easiest topic of equity splits:
Fairness – to all cofounders - is the only long term sustainable option
RISK should equal REWARD
For who & when is DES?
for start-ups that are using sweat equity to reward their cofounders for investing their resources
from as early as the team starts to work together until there is either sufficient cash flow to pay the cofounders for their work or by agreement of the cofounding team to fix
By far the most comprehensive dynamic equity split method is the Slicing Pie method developed by Mike Moyer.
How does it work?
Using the metaphor of baking a pie, you get a team together to make a pie and everyone on the team is promised a piece of the pie once the pie is baked. In the beginning, you did not even decide yet which pie you are going to bake. Is it going to be an apple pie? Chocolate brownie? Carrot cake? And who has the best recipe? And the main ingredients? Who can spend most time preparing the dough? The advantage of dynamic equity split is that it is OK not to have all the answers. You start baking the pie and just record the contribution of each baker. Before the pie goes into the oven, you calculate how large a piece of the pie goes to which baker based on how much she actually – not expectedly – contributed to the baking.
The basic philosophy behind Slicing Pie is that when someone contributes to a start-up company and is not paid in full for her contribution, she is at risk of never being paid. She is, in effect, ‘betting’ on the future value created by the company. The amount she bets is equal to the unpaid portion of the fair market value of her contribution. Her share of equity, therefore, should logically be based on her share of the bets.
Every person who contributes and is not getting paid is betting. Every day people place more bets in terms of money, time, relationships, facilities, supplies etc. Betting continues until the company breaks even or raises financing. At those points the betting typically stops because everyone can be paid for their contribution from then on.
It is impossible to know in advance how much betting will be required before (sufficient) value is created, but by keeping track of the bets you will always know the fair split for when it happens. In the Slicing Pie model, the contributions are tracked using a fictional unit of at-risk contribution called a ‘slice’. There is no end to how many slices a pie can have. At any given time the formula below will calculate a cofounder’s fair share:
Cofounder’s equity = Cofounder’s slices/all slices
The Slicing Pie formula is straightforward, simple and comprehensive. It includes all potential contributions that cofounders can bring to the table, dividing it into cash and non-cash categories. It measures the cofounders’ contributions over time and dynamically adjusts the equity ownership according to the accumulated contributions.
Next to the absolute fairness and transparency of allocating the equity, the DES as developed in the Slicing Pie Method also provides:
the recovery framework – aka what happens if a cofounder leaves the team
possibility to switch to it later (or verify how fair your fix equity split is) – retrofit
standardised solutions (template cofounding agreements)