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User:Kmsjogren/sandbox/Fairshare Model

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Fairshare Model

The Fairshare Model is a concept for how to structure equity interests in a corporation that raises venture capital via an initial public offering (IPO). It is described in the 2019 book "The Fairshare Model: A Performance-Based Capital Structure for Venture-Stage Initial Public Offerings" by Karl Sjogren. Venture-stage companies are generally unprofitable and present high failure risk for investors: a common characteristic is that they depend on fresh capital to survive, as they don't generate sufficient cash from operations to sustain themselves.

The Fairshare Model has two classes of stock--both vote but only one is tradable.

  • IPO and pre-IPO investors get the tradable stock. Employees get it too, for actual performance as of the IPO.
  • For future performance, employees get the non-tradable stock; it converts to the tradable stock based on milestones.

The Fairshare Model book refers to the tradable stock as "Investor Stock" and the non-tradable one as "Performance Stock." These names are used to aid comprehension. In practice, Investor Stock is common stock, and Investor Stock is preferred stock or a different class of common.

The performance criteria is set by the stock-issuing company (the issuer) and described in its offering disclosure document (i.e., prospectus). It can be changed after the IPO with the consent of both classes of stock. While the performance criteria can be whatever the parties agree on, five possible categories are:

  1. A rise in the market value of the tradable stock.
  2. Development milestones (i.e., release of a product or progress is obtaining regulatory approval to offer a product for sale).
  3. Financial measures like revenue and profit.
  4. The eventual acquisition price paid to acquire the issuer.
  5. Measures of social good, if relevant.

As milestones are met, non-tradable Performance Stock qualifies to convert to the tradable Investor Stock. As a result, at IPO, investors don't pay for future performance; rather, their ownership position is diluted based on the company's actual performance. In other words, their percentage of ownership in the value of the company will be reduced as performance milestones are achieved, but if those measures of performance have economic value, they will not suffer economic dilution. There is a saying among venture capitalists--"I would rather own a small slice of a big pie than a big slice of a small pie"--that describes the concept.

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