Fog Creek Software
Discussion Board




Pie Splitting in a new venture

Maybe do you have some field-proven methods for the following situation:

Name: Pie Splitting

Context:

A new venture is to be started with people from different backgrounds, let
say:

- a technical kind of person (w/ good knowledge of the technical issues like
platforms, tech team management etc)
- a marketing kind of person (w/ a view on the market and good ability to
spot opportunities)
- a business kind of person (w/ appropriate contacts in the market segment,
good background in the field (like 20 years experience)

There is a product to be developed and be pitched to prospects, which have
to be shown demos, being turned into customers etc.

So, a first phase of investment on the 3 perspectives has to be done.
Several expenses will be incurred during the development of the
product/solution/service offering.

When the product will be available, recurring sales will be done.

Also, support operations will be provided for customers.

It may also happen that money being collected from customers should be paid
as advances to the investors as part of the ROI.

To put ideas, the ROI period is expected to be something like 1 year - the
venture being expected to be a quick growth businesS.

Problem:

How is the pie to be split between the 3 profiles ?

Forces:

- every profile is different and cannot be "estimated" rationally since
there is a significant background in their respective domains. This is more
or less "goodwill".

- There is an investment in time, devlopment effort, marketing and
consciousness raising for quite a while when the product is being developed,
meaning that this investment should be translated in dollar figures in order
to be fairly compensated for each party.

- Expenses can occur during the course of the development of the product
(e.g. buying computers, printing advertising etc)

- Sales can occur and the product of the sale (once material costs of sales
and making  have been accounted for) has to be splitted between the parties.

- All parties want to be fair because they believe that it is the basis for
a quick growth where everyone is committed to the success of the venture.

Solutions:

- We tought of splitting the investment in 3 x 1/3 on a time and material
basis and then, split the product of the sales with repspect to "sales"
(X%), "technology" (Y%), "making of" (Z%) and "support" (Q%). Each of those
parts can then be splitted between the parties being involved in the phase
(e.g; for "Sales", the business person and the tech person work together,
gathering prospects and building up a demo --> X% =n is splitted again in  a
% and b%).
The splitting is decided on a per project basis.
The first sales are used to refund the investment.

But this is not as easy a we wanted because product development, sales,
research etc are all occuring simultaneously in an iterative way. This is
basically the same kind of thing as RUP in practice w/ lots of interwined
workflows.

Resulting Context:

A documented compensation scheme is established and the involved parties are
satisfied w/ the deal.


Thanks for your toughts on this.

Philippe Back
Tuesday, December 17, 2002

This is intended to be a business?

Where is your business plan?  In the business plan should be included the capital required and the drawings of each of the participants, whether that's treated as salary or some kind of % in which case its a partnership.

Whatever the split, it can't add up to 100%, the business you create is entitled to a share as well (something frequently forgotten).

As for relative proportions between different functions, if its a matter of trust then, questions of capital investment aside, the relative salary or drawings should be equivalent.  In any event you will need some kind of legal agreement between everyone.

Simon Lucy
Tuesday, December 17, 2002

Thanks for this.

Some clarifications:

It's meant to be a partnership (3 people/ 3 different background).

We are quite okay when it comes to producing a business plan for the business itself (projections, estimates, requirements etc). But this pie splitting thing is really difficult to do.

The question of trust is fine now (but we need to write down a contract specifying how pie splitting would be done). Just in case there are difficult times, so all parties can fall back on the written engagement (have been bitten before, so no way to go without now).

To avoid those issues I usually subcontract parts of the jobs to other people w/ a pretty clear contract but here, this is another level: it's building up the business from scratch and not working for a customer as a developer (It's more of a move into a space where we will create some kind of full service for a specific market segment - the goal is to really grow all kinds of offerings that will not all be tech based).

Any further idea ? I dug into this subject but this is not much discussed as I could see.

Philippe Back
Tuesday, December 17, 2002

If its a partnership then there are standard partnership agreements in other professions, http://www.google.com/search?q=partnership%20agreement%20model&sourceid=mozilla-search&start=0&start=0&ie=utf-8&oe=utf-8

Gives a bunch.

In terms of salary, for partners its not quite the same as dealing with employees.  For instance, at the end of the financial year, or however often you agree to it, there is a division of the net profit of the partnership.  So you tend to pay partners less than their market value, especially when starting up.

Remember you'll pay tax at both ends.

So rather than think about who should get paid what, from your business plan forecast your likely yield from the partnership and allocate a proportion of that as salary, individual partners can vary their salary but can't take more than the pro rata of their share of the forecast for the year.

If as you trade you discover that you were over optimistic as to how much you were going to make then you can adjust it in the 'salary', technically drawings, or forego them completely if needed.

If though you find that you are making more than your forecasted profit don't be tempted to increase your monthly drawings, otherwise you'll start to hinder the business itself, instead of taking extra profit  convert it as capital.

Simon Lucy
Tuesday, December 17, 2002

Great !

I will take this advice and build up a scheme that can be discussed w/ the partners.

I'll google this query and see what  I can get out of that.

Thanks again.

Philippe Back
Tuesday, December 17, 2002

The kind of product you produce should influence who partners are. Why? If you are high tech, something very new to the world, you will want partners that can understand the product and how to sell it. Some business types just can't make that jump.

Be wary of the sales person that says they can sell anything. Very wary, when they say they don't even need to learn about product.

Do not allow Golden Parachutes. Otherwise, you will get to watch large chucks of the organization's money go, when a executive leaves the organization.

Be wary if business types start wanting to buy other companies (profit streams). Ask yourself this, why would a company that is doing well want to be bought. If you have been able to establish a organization that can score well to the Joel test, buying a company that doesn't will hurt your organization.

David Hickerson
Tuesday, December 17, 2002

I am going to throw a spanner in the works, and propose a very simple structure.

There *really* needs to be a clear disctinction between the funding of the business (capital), and its operations (costs/activities/profits).


CAPITAL
What I think you should do is split the profits according to the shareholding in the business... aka the value (not only just amount of money) that each party is bringing to the table.

If one or more of you feel that they are bringing in more expertise to the business, then treat it as goodwill (you can read about accounting for goodwill in any half decent "start your own business" book).

For example, you might all contribute £10 to the business, and have the tech guy end up with £15 of the equity, because of the £5 value you place on his goodwill.

You may also have window periods (say quarterly ... just after the quarterly accounts) where the partners can convert their parts of their salaries into equity.... This is similar to a business issuing more shares, and the partners investing more money in it.

The dividend at the end of the year (which again you can capitalise) would be distributed according to the ratio of shares held. If you hold 25% of the shares, you will be entitled to 25% of the profits. Whether the business distributes *all* the profits or retains some of them for re-investment is a business descision.

In essence, each partner is treating their shareholding in the business as a normal investment. The fact that you happen to work for the business is incidental.


OPERATIONS
You should have standard employment contracts between the business, and *each* of the partners. You work for the business. Once again, the fact that you also hold shares in it is incidental.

In your role as an employee, you earn whatever you have negotiated. Whether you choose to convert part of this into shares, and therefore get a larger share of the shareholders profits, is an investment decision you make as an individual. It should have no bearings whatsoever in your role as an employee.

You might be to pay straight salaries, you might have hourly rates, per project rates, basic salary with per project bonus ... this is an operational decision. Nothing to do with who owns the business. Only a question to be answered in a manner that ensures the long term profitability of the business.

The problem with sharing *all* the revenues *only* on a per project basis (especially if the business has been incorporated) is that it begins to get really messy when you have outside investors (who do not work for the company). Simon Lucy kinda alluded to this when he said that you have to remember that the business you create is entitled to a share as well.

If your performance as an employee begins to threaten the viability of the business, you should be fire-able (is that a proper word?). Whether you are fired or not however, will not impact on your shareholding of the business. You will still be entitled to your share of the profit. What you will not be able to do, is  draw a salary like the other partners who are still working for the business.

On a more positive note though, you should be able to quit the business, and not have it collapse. You will still be a shareholder (and entitled to profit) even if you are fly-fishing in BoraBora.


RESULT
1. Your rights and responsibilities as a shareholder:
You have one document as shareholders, documenting the share structure (ord vs pref shares etc), the initial shareholding (a x%, b y% etc), methods of increasing/decreasing one's shareholding (when? valuation of business/shares, limits etc), disbursement of the business profits (when, who decides dividend vs capitalisation etc).

2. You right and responsibilities as an employee:
The second document will detail your compensation for your day to day involvement in the operations of the business (aka employment contract). For some this might be just a straight salary, bonus based on profitability (business dudes), bonus based on project completion (techies), bonus based on new business or sales (marketing) etc etc (get creative, but keep it simple).

Non compete clauses, golden parachutes (which David pointed out are a bad thing) etc are in this section.

tapiwa
Wednesday, December 18, 2002

A couple more thoughts:

Problem:  Partnerships often fall apart when the partners don't have a crystal clear understanding of each persons' responsibilities.  This happens especially often when the partners aren't all old buddies.

Therefore:  Write a contract that specifies each partner's specific responsibilities.

So, we'll assume that the partners are all good friends, or that their responsibilities are defined with diamond precision.

You might want to seriously consider giving each partner an equal share.  The point of paying people is to pay for their work.  You should trust that each partner is working as hard as s/he can, and thus they're all working equally.  If you can't make that assumption, _don't form the partnership_.

On the other hand, it may become clear that the division of labor will be uneven for very valid reasons.  That's one way in which the contract can be handy; it will elucidate each person's workload, and you can more precisely estimate the appropriate compensation that way.

Brent P. Newhall
Wednesday, December 18, 2002

Great advice, I think that I will have quite some interesting hours spent putting all this together...

This "share-oriented" way of thinking is quite useful when it comes to the evolution of the biz.

Philippe Back
Wednesday, December 18, 2002

Not too informed on corporate law in the US (where I assume you are), but one of the benefits of incorporating is that your loses are limited to what you invest in the business.

Partnerships on the other hand (UK and most of sub-Sahara Africa), tend to have not limit on the "joint and several liabilities" of the partners on the losses of the business.

tapiwa
Thursday, December 19, 2002

I believe that tapiwa is correct (IANAL).  One partner can take everything and kick off to the Bahamas, and the other partners can do *nothing*, unless their contract specifies otherwise.

(Though even if you do have legal recourse, do you really want to go through a lawsuit?  Much better to be absolutely sure of the participants, *then* write a specific contract.)

Brent P. Newhall
Thursday, December 19, 2002

IANAL?

I hope that's not a COM component.

Dunno Wair
Monday, December 23, 2002

IANAL= I am not a lawyer

tapiwa
Saturday, December 28, 2002

*  Recent Topics

*  Fog Creek Home