Dynamic Equity Overview
Dynamic equity is a away of allocating equity to venture contributors.
In traditional "fixed equity" agreements, founders of a new venture typically divide the initial shares equally (ex. 50:50) and "give up" parts of their equity to investors over time.
In dynamic equity, founders and other contributors start at 0 and "earn" equity over time. Frameworks like Slicing Pie provide more details about how to do this fairly (ex. "slices" are earned based on the market-equivalent cash value of the work of the contributor; cash investments have a 2x preference, etc.).
Why is dynamic equity preferable to fixed equity?
- makes it much easier to start a venture with non-equal contributions (ex. one part time founder; one full-time; one full-time but paid a small salary)
- better deals with unexpected changes (ex. founder needing to leave because Life Happensā¢)
- mitigates venture-killing founder "break-ups"
- makes it easier to give significant equity to early employees (possible also to continue with this model forever --- similar to a worker co-op)
- makes it possible to involve short-term contributors for equity (ex. a $5,000 logo design)
fixed-equity:
on day 1, grant tokens between founders (ex. 2 founders, 50:50)
cliffs and vesting
problems:
typically make a fixed split at point of highest uncertainty
guessing at future value contributions
difficult to change later
"life happens"
dynamic-equity:
grant tokens over time for 'sweat equity' and other contributions, as they are made
benefits of dynamic equity:
- don't need to have fixed and equal expectations at start
- framework for pricing actual contributions fairly (ie. market-rate-comparable)
- life happens, can adapt fairly
- can "compensate" minor contributors w/ equity
principle:
what you put at risk : your share of the reward
what you put at risk : market value equivalent
2x multiplier for cash
rationale: (from slicing pie)
cash is harder to come by
cash is post-tax; labour is pre-tax
issue:
'cycling money shenanigans':
scenario A:
work 1 hr for $100, get 100 slices
net:
100 slices, -1hr
scenario B:
invest $100, get 200 slices
work 1 hr for $100 pay (taxed at individual's tax rate + HST; tax expense for corp)
net: (assuming 15% tax rate for indiv and corp)
200 slices, -15$, -1hr; corp: 15$ tax credit
Under DE, equity is 'earned' through 'work actually done', not, 'future potential work'.
dynamic equity can be seen of as a 'mental trick'
instead of thinking about 'pie as 100%, and giving away percents' as the pie grows;
instead, it's 'pie starts at 0; we grow it together'
importantly:
contributors understand that 'they are contributing over time to keep increasing their share' (vs in fixed equity, where they "get 30%" and might "lose it" if they leave early)
Token Interest
Every month, on the first of the month, all tokenholders earn 0.5% in bonus tokens
Why?
to account for early-stage-risk
to account for 'time value of opportunity cost'
motivate keeping tokens rather than cashing out
(amount was chosen to approximate return of equity on stock market, 0.5% monthly = 6.16% annual)
Splits / Global Bonus
Occasionally, typically at most once a year rarely, a venture may peform a token split; increasing the percent of outstanding tokens by a certain percentage, equally to all tokenholders (effectively granting 'bonus interest' to all tokenholders).
Why?
continue with practice of 1 token = 1 market-equivalent-dollar
but, account for change in risk of venture
generally: 100$ in first year of venture =/= 100$ in third year, when venture is profitable
A split would typically happen upon certain milestones being reached (ex. break-even, net-even, after a priced investment round)
Incentives:
too aggressive bonus, you alienate future contributors
people that cashed-out within a certain period before "bonus", should have option to undo?
(or at least, the way it's applied is based not on "tokens as of Dec 31", but, rather, tokens as of Jan 31, Feb 28, etc...)
(and/or, rule: no auctions X months before bonus announcement)
FAQ
But what about incentivizing major contributors?
DE still allows for a major upside. Major contributors still own a significant percentage of a venture. DE provides a way to determine that percentage fairly between major contributors, and between major and minor conatributors, and in a way that better handles changes.
Under DE, contributors are always incentivized to make further contributions, both to (a) grow their share of the venture, and (b) to increase the value of their shares (by increasing the value of the venture).
With fixed equity, once a contributor finishes vesting, there's a significant discontinuity in their incentives.
Why no cliff? Why no vesting?
The main problem that cliff and vesting provisions address for fixed-equity agreements is 'what if a major contributor leaves early'. Under DE, the answer is: they keep the tokens they 'earned' to that point, and after leaving their shares get diluted over time, in a 'fair', restricted, non-arbitrary way.
So a contributor still gets to keep shares even if they've left the venture?
Yes.
Fundamentally, we believe that work done deserves to be recognized.
It's really about expectations. Under FE, because founders typically start with an equal share (of say, 33% in a team of three), then there's an expectataion tht they all contribute the same (and this tends to push towards 'full time, for at least 5 years').
DE allows for more fluid expectations: if the three founders all work equally for 5 yyears, their shares will be similar as with FE, but, DE makes handling changes easier (ex. 'Partner 2 needs to switch to part-time after 2 years') and including more contributors, as the venture evolves, in a fair way.
What stops someone from making up the time they spent, or greatly inflating it?
This problem exists with cash-based contracts too.
As a Steward, when starting to work with a new contributor whom you don't trust, you can start small and increase trust over time. We suggest:
- start with project-based contracts, with clear expectations
- start with short time commitments (ex. 5 hours)
The most likely conflict is for a new contributor too takes longer to perform some task than a Steward expected (ie. not a lie, just a mis-estimation). In that case, the Steward can renegotiate the rate going forward or stop engaging that contributor in the future.
For work done up to that point, the Steward can:
- buyout out the contributor with cash (within a 3-month window)
- let them keep the tokens (which shouldn't be a big deal, because of limited rights of minority stakeholders; and dilution)
For extreme cases, where a significant fraud is committed, the Steward can seek
arbitration, or have the issue handled by existing criminal and civil law relating to fraud.
What if Alice is 'slower' / 'less effective' than Bob (say, at mobile app development)?
This problem exists with cash-based contracts too.
Stewards are free to negotiate contract terms with contributors, which allows for different contributors doing similar work to be allocated tokens at different rates (ex. a Senior Developer at 150 tokens/hour, vs. a Junior Developer at 50 tokens/hour).
Notea that all contracts and all token grants are visible to all contributors, so, Stewards can expect some pushback if rates are significantly out-of-sync.
In the given example, if Alice underperforms Bob, either 'give Bob a raise' or 'renogotiate Alice's compensation', or, help train Alice, or keep things as they are if everyone is happy.
If someone regularly performs below expectations, you can adjust the compensation, or stop working with that person.