Australian legal approach to dynamic equity split / grunt fund

[Jim May]

Hi Silicon beachers,

We're setting up our new startup and working through the legals associated with starting a company.

I started by downloading the Startmate Shareholders Agreement (http://www.startmate.com.au/financing-docs) and similar docs. They're great (e.g. I like the approach to 4 year vesting) but given we're not going to be working equal amounts in the early stages we'd like a more flexible structure where the amount vested can be adjusted over that time. Slicing Pie (http://www.slicingpie.com/) proposes what seems like a fair model based on effort and input, but seems like it could be a little complicated to administer. Also, I've heard that there could be some legal issues implementing this model in Australia.

Does anyone suggest an approach and how to capture it in the legal docs? E.g. Here's some ideas:

1) Allocate shares and vesting based on the ratios we foresee right now. Meet periodically and issue new shares to re-balance things based on a pre-agreed method.

2) Issue new shares every month (or quarter or year) based on tracked effort over that period.

3) Somehow issue shares into a fund, that is then issued to founders over time. What's the legal implementation of this concept?

4) Other ideas?

How should this be reflected in the shareholders agreement or other docs?

Cheers,

   Jim

[blindman2k]

Hi Jim,

My accountant just gave me advice that it is very risky to issue shares-for-effort in Australia because they will be deemed to be income and taxed up front. I came on here to ask the same question. Has anyone else out there made a scheme like this work in Australia?

    A.

[Jim May]

Hi there "A",

Wow - didn't think of that. Thanks for the info. Looks like this needs more thought/input.

Cheers,

   Jim

[Saxon Druce]

Yes, you can't issue shares later (once the company is theoretically worth something), as then you'll be taxed at the time of issue on the (theoretical) value, rather than being taxed later when the shares are actually sold for an actual value.

This is why in vesting arrangements you are actually issued all of the shares up-front, but agree to sell back to the company some percentage of your shares at some nominal amount (like 1c/share) if you leave early.

A while ago I started a company with a friend, and we weren't sure how much effort each of us would be able to put in over the 4 year vesting period (we were both working on it part time), and so what split was fair. We came up with something which extended the vesting buy-back idea, to allow for changes in equity split as well.

At the beginning we issued half of the shares to each of us, eg with 100 shares we got 50 each. The agreement was that if by the end of the 4 years we agreed that the split should have been eg 60/40 instead, then the person with 40 would sell 17 of their shares back to the company. That way person A has 50/83 = 60%, and person B has 33/83 = 40%.

When we started we decided on an initial most-likely split, and then agreed to meet up every quarter to discuss if it should be changed. During the first year or two it might change a lot, as everyone is working out what they can commit. Later on it would probably stabilize and change less.

Is this legal? I have no idea, it was just something we made up :) It seems no less legal than normal vesting buy-back? Ultimately the company folded after a year or so, so we never tested it seriously.

I imagine an investor would find this scheme crazy, and so be turned off. Maybe a small seed investor could be convinced that their cash is worth a variable amount in relation to the variable amount of effort that the part time founders are putting in, and so they could also participate in the quarterly "is everybody still happy with this split" meeting.

A more serious investor is probably not going to want a variable amount of equity. However if you're taking on serious investment you probably need to make a serious commitment to the business, eg all founders working full time. You might be better off deciding to lock down the equity split (and do the buy backs) before taking on the investment.

Saxon

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[Tom Allen]

Important caveat: we're still finalising this stuff with our lawyer & accountant. It may be bollocks, or illegal, or both!

Our approach has simply been to invoice the company for our time at some nominal $/hr rate, but then let the company forgo payment indefinitely. If the company generates revenue or raises capital we will either pay back the loans in cash (with some nominal interest rate - IIRC our accountant suggested we needed to beat inflation for the tax office to consider it a "real" loan), or we'll issue equity then (which will have a value, and thus will be taxable). Effectively we're consultants to a company that hasn't paid us yet.

In the equity case, assuming the company had the cash, it could reduce everyone's equity payout by the amount of cash needed for them to pay their taxes, and give them that cash too. Transcendental equations suck, but this seemed plausible.

We're increasingly close to the crunch point where we really will need to sort this out more formally and legally, rather than just amicably, so I can hopefully report the final form of this setup soon.

Cheers,

Tom

Tom Allen

t...@jugglethis.net

+61 412 335 425

http://www.drtomallen.com

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[Jeromy Evans]

On 25 Mar 2015, at 12:29 am, blindman2k <aron...@bcde.com.au> wrote:

Hi Jim,

My accountant just gave me advice that it is very risky to issue shares-for-effort in Australia because they will be deemed to be income and taxed up front. I came on here to ask the same question. Has anyone else out there made a scheme like this work in Australia?

    A.

I’ve been through this in Australia and it’s fine to do it.  Yes, the employee pays tax up-front on the value of the shares for the tax-year they’re issued.  This is annoying and unfortunate, but acceptable to do. The income tax paid on the shares today form part of the costbase for evaluating the employee's capital gains tax at the future CGT event. It works and there’s little risk to the employee or company (other than setting a valuation on those shares when perhaps you shouldn’t yet). It sucks for employees, but is do-able.  

[blindman2k]

http://www.afr.com/technology/tech-startups-back-overdue-employee-share-scheme-law-20150325-1m7dun

This looks like a positive change.

   A.

[Mike Moyer]

Hi Jim,

I invented the Grunt Fund and I'll be in Australia in June 2015, there are a lot of people in Australia trying to solve this problem. Before my trip I'll make sure I'm up to speed on best practices. Be sure to join the mailing list at SlicingPie.com to be notified of Slicing Pie events in your area!

I promise that there is a legal, tax-friendly way to implement a Grunt Fund!

-Mike

[Jim May]

Hi Mike,

Thanks for joining the thread. The govt has changed the situation since this thread was first posted so things are looking up. There are still lots of questions though so I'm certainly looking forward to hearing more.

Cheers,

   Jim

[Kurt Falkenstein]

Our law firm General Standards has prepared an Australian version of the Grunt Fund, based on the dynamic equity concept and LLC operating agreement available through Slicing Pie.

It isn't possible to do in all circumstances, but if you have your team together and your unincorporated, it should be possible with minimal risk.

You can book a meeting with us if you wish to discuss implementing a grunt fund - http://generalstandards.co/#booking - (we don't do it for free, but it's affordable) 

Kurt Falkenstein

ku...@generalstandards.co

[Elias Bizannes]

Hi Kurt, great to see you are back on email. However this time on a listserv that coincidently is the same thing that inspired me to create StartupBus to help build the Aussie ecosystem, a thing you theoretically sponsored twice. 

And like you, I also don't do free, if you recall from our agreement. 

Maybe you can respond to my multiple unanswered emails to pay me for the sponsorship you did for StartupBus Australia in August and Europe in October 2014 before you schedule meetings from this community. 

_____________________________
From: Kurt Falkenstein <ku...@sunship.com.au>
Sent: Monday, April 13, 2015 8:08 AM
Subject: [SiliconBeach] Re: Australian legal approach to dynamic equity split / grunt fund
To: <silicon-bea...@googlegroups.com>

Our law firm General Standards has prepared an Australian version of the Grunt Fund, based on the dynamic equity concept and LLC operating agreement available through Slicing Pie.

It isn't possible to do in all circumstances, but if you have your team together and your unincorporated, it should be possible with minimal risk.

You can book a meeting with us if you wish to discuss implementing a grunt fund - http://generalstandards.co/#booking - (we don't do it for free, but it's affordable) 

Kurt Falkenstein

ku...@generalstandards.co

On Sunday, April 12, 2015 at 10:51:50 AM UTC+10, Jim May wrote:

Hi Mike,

Thanks for joining the thread. The govt has changed the situation since this thread was first posted so things are looking up. There are still lots of questions though so I'm certainly looking forward to hearing more.

Cheers,

   Jim

On Sunday, 12 April 2015 10:00:11 UTC+10, Mike Moyer wrote:

Hi Jim,

I invented the Grunt Fund and I'll be in Australia in June 2015, there are a lot of people in Australia trying to solve this problem. Before my trip I'll make sure I'm up to speed on best practices. Be sure to join the mailing list at SlicingPie.com to be notified of Slicing Pie events in your area!

I promise that there is a legal, tax-friendly way to implement a Grunt Fund!

-Mike

On Friday, March 13, 2015 at 12:46:50 AM UTC-5, Jim May wrote:

Hi Silicon beachers,

We're setting up our new startup and working through the legals associated with starting a company.

I started by downloading the Startmate Shareholders Agreement ( http://www.startmate.com.au/financing-docs) and similar docs. They're great (e.g. I like the approach to 4 year vesting) but given we're not going to be working equal amounts in the early stages we'd like a more flexible structure where the amount vested can be adjusted over that time. Slicing Pie ( http://www.slicingpie.com/) proposes what seems like a fair model based on effort and input, but seems like it could be a little complicated to administer. Also, I've heard that there could be some legal issues implementing this model in Australia.

Does anyone suggest an approach and how to capture it in the legal docs? E.g. Here's some ideas:

1) Allocate shares and vesting based on the ratios we foresee right now. Meet periodically and issue new shares to re-balance things based on a pre-agreed method.

2) Issue new shares every month (or quarter or year) based on tracked effort over that period.

3) Somehow issue shares into a fund, that is then issued to founders over time. What's the legal implementation of this concept?

4) Other ideas?

How should this be reflected in the shareholders agreement or other docs?

Cheers,

   Jim

--

[Mike Moyer]

Hi Kurt,

Last year I referred hundreds of readers to attorneys in the US who were seeking to have a Grunt Fund set up. Would you be interested in talking about becoming a Grunt Fund friendly lawyer for Australia?

-Mike

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Mike Moyer

miked...@gmail.com

(773) 426-6353

Become a Pitch Ninja with Mike's new book, Pitch Ninja!

[Mike Moyer]

I understand some laws were changed recently. I'll post what I find out to my blog on SlicingPie.com

-Mike

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[Kurt Falkenstein]

Elias, since you want to put things out in the open, then let's have this discussion on-list.

Our UK office will pay you, as it has been indicated to them that you haven't paid some of your UK team. I hardly think our sponsorship is the reason for this, but no doubt you'll at least attempt to point the finger. So we'll pay you the 1,000GBP but make sure you pay your people with it, lest you be seen as a hypocrite.

However in Australia you decided to tear me down personally, in a community where we're both known. Even though I wrote and gave you the benefit of the doubt that it was an accident, you confirmed it wasn't, but then you offered remove the post once you get paid - you weren't even willing to pretend to not be an arsehole. I hope that this gave you $2,000 worth of joy because there is no way in the world I will ever give you a cent. You've taken payment with a pound of flesh.

This list was not made for public spats, you of all people should know that, and if someone else initiated such a thread you or another admin would have moderated it - but it seems you don't mind bending your own standards, and abusing your own position, to serve your own ends.

Kurt Falkenstein
Sunship Ventures
Melbourne, Australia

ku...@sunship.com.au
Phone: +61 405 235 258
Twitter: @kurtfalkenstein
Web: www.sunshipventures.com

"When you're curious, you find lots of interesting things to do." - Walt Disney

[Elias Bizannes]

Hi everyone,

I just want to apologise for that snarky email I sent to the entire list. That shouldn't have happened. Kurt's response was also mis-informed and things are all good.

For the record, he has paid the UK bill I needed and we're getting resolved the Australian bill within a day. For those that reached out, please don't interpret this incident as a negative on him and I feel I should say the following to make up for my unintentional damage, something I've said before in other forums.

Kurt's a rockstar layer who I recommend whenever I'm asked for a good Australian startup lawyer. Not just because he's comes with a kick arse business model that's perfect for startups (low price high volume business model versus a low volume high priced offering other legal firms do for what is the same advice and should be standardised -- see for yourself http://generalstandards.co/au/) but because he's a serial entrepreneur himself. When getting advice for a startup, entrepreneurs are the best people to get it from -- so it's pretty unique to have a lawyer that's like that.

...And I've had many beers with him after spending three stinky days on (startup)bus from Melbourne, so I'm not just saying this as I've spent way too much time with him. He just sucks at email, especially requests to clarify an outstanding debtor issue that he himself started a conversation on to resolve. :)

Elias

Elias Bizannes
http://eliasbizannes.com

[blindman2k]

I am glad to see you two kids making good. It was getting pretty ugly and I thought I might have to step in soon.

[Matthew Ho]

Glad you guys could sort it out :)