The fairshare model is a new suggestion that provides a performance-based capital structure for companies that raise venture capital via a public offering. It has been proposed in 2014 by Karl M Sjogren, who is writing a book about this interesting idea. The vision is compelling, and its core idea is the following, as outlined by Sjogren:
“Middle class investors will be able to make venture capital investments on terms comparable to those that professional investors get.”
There are a number of goals behind this idea. One is that this will provide the opportunity for entrepreneurs to increase their access to capital. The second is that it will create liquidity for angel investors that support private companies. The third is to create an option for middle class investors to be able to become mini angel investors. Sjogren suggests that the target for the fairshare model should be companies that have already raised a round or two of investment from angel investors and that need $5 million or more in venture capital. It is proposed that there is no limit on the amount that can be raised, and that it is designed to raise public capital for a venture-stage company. It is also suggested that there should be two classes of stock. These should be investor stock and performance stock. While both would be able to vote, only investor stock would be able to trade. Performance stock could change to investor stock based on performance. It is also envisaged that there would be approval from each class of stock for board member election, change to conversion criteria, compensation plans that involve investor stock, changes to capital structure and acquisition matters.
What are the differences from the conventional investing model ?
When comparing the fairshare model with the conventional cap structure it is explained that under the conventional cap structure, a value for future performance has to be set when a company issues new stock. Additionally if there is complexity, the purpose of that is to favour pre-IPO shareholders rather than public shareholders. Conversely the fairshare model has a low risk of overpayment for IPO investors, and post-IPO valuation is shared with performance stockholders too. It is believed that this helps to address the current problem of valuation with the conventional model. Sjogren explains that when equity financing occurs this means that the issuer and investors have to set a value for future performance, and this is challenging to achieve in a rational manner because it requires the need to value undelivered performance. What this fundamentally means is that the conventional model and the fairshare model differ in terms of how they deal with uncertainty. With the fairshare model uncertainty is moved. The conventional model creates certainty in the area of ownership interests which are set at financing. Meanwhile there is uncertainty around whether performance will be delivered and just how valuable that will be. Meanwhile the fairshare model has uncertainty regarding how much performance stock will convert. However, there is certainty around when performance has been delivered, and the value of that is apparent.
What all of this means is that currently VCs are able to side step the valuation problem and buy in at a higher valuation. If the valuation does not increase enough, investors with price protection are able to get additional shares for the money that they put in initially (Sjogren, 2014). This leaves the valuation risk to be firmly placed with the public investors as they have most to lose, have no price protection and suffer from the fact that an IPO valuation is speculative.
What are the challenges of the fairshare model ?
Sjogren acknowledges that the fairshare model will have its challenges. It requires that many people support the idea and that they make a lot of noise about it so that others get involved and also lobby for it. There is also the problem of the so-called “ponderables” which need to be debated. These ponderables include how performance can be defined and who should define it, how it should be measured and who should measure it, how the rewards should be allocated and who should administer them. Tax and accounting implications also need to be clearly addressed. In addition, just the challenge of simply progressing through the change from the current situation to the new way of being will provide issues in itself, but it is thought that it is achievable.
Sjogren states that this middle will, “boldly go where no capital structure has gone before.” Will you go with it?
For more information about the fairshare model please check the following power point:
Paula Newton is a business writer, editor and management consultant with extensive experience writing and consulting for both start-ups and long established companies. She has ten years management and leadership experience gained at BSkyB in London and Viva Travel Guides in Quito, Ecuador, giving her a depth of insight into innovation in international business. With an MBA from the University of Hull and many years of experience running her own business consultancy, Paula’s background allows her to connect with a diverse range of clients, including cutting edge technology and web-based start-ups but also multinationals in need of assistance. Paula has played a defining role in shaping organizational strategy for a wide range of different organizations, including for-profit, NGOs and charities. Paula has also served on the Board of Directors for the South American Explorers Club in Quito, Ecuador.