Slicing Pie Provides Angels Big Advantages Over Convertible Notes

Updated: Oct 12, 2022

Angels, Before Investing, Ask Your Founders About Slicing Pie

If you have had a chance to work with me recently or read my blogs then you know I am a big fan of the Slicing Pie Model. In pharma, sometimes drugs have an 'after market' effect where positive results are realized in unexpected areas. Whether Slicing Pie is as good as aspirin is to be seen but this blog describes how it can be wielded as a "first money in" investment model. Mike Moyer, Founder of Slicing Pie, somewhat touches upon this idea in his blog, The 3.5 Types of Startup Investors. I push the concept a bit harder by comparing its advantages over convertible notes and SAFE.

Angel Investors are an important, critical element of the early stage startup community. They usually represent the second level of funding following “Friends and Family” in individual amounts hovering between $30k-$50k for a total round between $250k-$750k. They take big risks at a time when the company is just beginning, experimenting, pivoting and making mistakes.

Angels often receive convertible notes or SAFE notes where the ownership % is deferred until later rounds when the company has a recognized valuation through a priced round. The amounts awarded after valuation too often don’t reflect the risk of putting up as much cash as they do as early as they do. Convertible notes work the same whether a startup founder meandered and took on three more angel rounds to find its way, or went straight to priced seed round in 6 months. The percentage ownership angels realize after valuation needs to better reflect their risk of putting up that much cash so early on in the life of the company.

Wouldn’t it be great if we could deservingly reward angels for their early stage risk and at the same time make the startup more attractive to all “first money in” investors? A version of the dynamic equity split methods called Slicing Pie may be the answer.

The math details are shown below exemplified through an investment scenario where two partners start a company with an angel investor concluding with the first priced round. This example demonstrates a 10x benefit to ‘first money in’ when angels invest using Slicing Pie methods over convertible notes.

The base scenario is similar to Caya’s, CEO at Slidebean, convertible note lesson: Convertible Notes Explained: Startup Funding. The example also reasonably parallels an actual scenario for a recent Blink Fusion actvestment.

Let’s compare convertible notes against Slicing Pie methods using the following scenario encompassing a one year period and beginning year two.

Walter and Jesse start a company with the intention of sharing equity equally.
Gus invests $200,000 at the beginning of year 1
At the beginning of year two, Madrigal invests $1m and sets the value of the company at $5m.

Year 1	Year 2
Two founders. Walter: 500,000 shares Jesse: 500,000 shares Gus: Angel Investor Convertible Note Terms Investment: $200,000 Interest: 5% Discount: 20% Cap: $5m	Madrigal invests $1m Establishes the value of the company at $5m

Calculations

Gus gets his shares before Madrigal to compensate him for believing in the company early on.

Year Two	Calculate Gus’ Ownership
Founder Shares Walter: 500,000 Jesse: 500,000 Gus: Angel Investor Convertible Note Terms Investment: $200,000 Interest after 1 year Total: $210,000	The valuation of the company per Madrigal is $5m but Gus negotiated a 20% discount so Gus’ valuation is $5m * .2 = $4m Gus % = $210,000/$4,000,000 x 100 = 5.25% Founders Walter and Jesse have 1m shares. Gus’s shares = 5.25% of 1m = 52, 500 shares Total Shares in Company: 1,052,500

Year Two	Calculate Madrigal Ownership
Founder Shares Walter: 500,000 Jesse: 500,000 Gus: Angel Investor Convertible Note Terms Investment + Interest: $210,000 Total Shares: 52,500	$1m investment with $5m valuation Madrigal % = $1m/$5m x 100 = 20% Total existing shares Walter, Jesse and Gus : 1,052,500 Madrigal’s shares = 20% of 1,052,500 = 210, 500 shares Total Shares in Company: 1,263,000

Ownership Summary for Convertible Note Model

Starting Shares: 1,000,000

Shares for Gus: 52,500

Shares for Madrigal 210,500

Total Company Shares: 1,263,000

Name	Shares	% Ownership
Walter	500,000	40%
Jesse	500,000	40%
Gus	52,500	4%
Madrigal	210,500	16%

Slicing Pie Model

The model is based on Mike Moyer’s Slicing Pie for Perfect Equity Splits. Equity is dynamic while the pie is baking. For simplicity let’s assume partners Walter and Jesse contribute time equally throughout the year which rarely happens in practice.

Year 1	Year 2
Two founders Invest Market Rate Salaries Walter: $200,000 per year Jesse: $200,000 per year Deferred salary realizes 2x slices Walter: 400,000 slices Jesse: 400,000 slices *Gus: Angel Investor* Investment: $200,000 Cash realizes 4x slices Gus: 800,000 slices	Madrigal invests $1m Establishes the value of the company at $5m 5m shares are established

Moving towards a fully baked pie where the equity is locked.

Year Two (pie is locked)	Calculate Ownership
Deferred salary realizes 2x slices Walter: 400,000 slices : 25% Jesse: 400,000 slices : 25% Cash realizes 4x slices Gus: 800,000 slices : 50%	The valuation of the company per Madrigal is $5m with a $1m investment. Madrigal % = $1m/$5m x 100 = 20% Leaving 80% to be divided by the Slicing Pie owners. Walter: 25% of 80% = 20% Jesse: 25% of 80% = 20% Gus: 50% of 80% = 40%

Ownership Summary for Slicing Pie Model

Name	Shares	% Ownership
Walter	1,000,000	20%
Jesse	1,000,000	20%
Gus	2,000,000	40%
Madrigal	1,000,000	20%

Conclusion

The Slicing Pie Model has some noticeable advantages that pair nicely with the real world:

Note the simplicity of the calculations over convertible notes
Cash investment (4x) is recognized and respected over salary investment (2x) to support perfect equity splits
Angel Investors who take the most risk of any subsequent investor are given the respect they deserve
Priced round investors maximize % ownership without competing against prior deals such as convertible note interest and discounts
It keeps going even if the startup bounces along for a while as well as if it closes out quickly given the startup experiences unanticipated success, rewarding the investor fairly in either circumstance.