The allocation framework consists of a basic set of calculations that define the number of slices received in exchange for various contributions based, in part, on the fair market value of the contribution and, in part, on a multiplier for cash and non-cash inputs.

Non-cash contributions include time, ideas, relationships (that turn into customers, suppliers, employees or investors), pre-owned equipment or supplies and some resources such as office space. Cash contributions consist primarily of unreimbursed expenses and, of course, cash.

Using the calculations from the allocation framework, an individual’s contributions are converted to slices and their portion of the company is calculated on a rolling basis using the following formula at any given time:

The formula ensures that equity or profit interest allocation remains fair, in spite of changes the firm might encounter. As time goes by, work is done, people come and go, sales are made, and business is conducted. The number of slices in the model, therefore, is always changing.

You may be uncomfortable with the dynamic nature of the model at first. Once you get your head around how this works, you will see the importance of the dynamic model and its ability to ensure fairness. I promise that if you use this model you will always have what you deserve. You may not have what you desire, but you will certainly have what you deserve.

The dynamic model takes into account the inherent volatility of a startup environment whereas a fixed split makes the false assumption that the future can be known or accurately predicted or that everyone always does exactly what they say they are going to do. Under all circumstances, a dynamic model is going to be fairer than a fixed model.

Calculations

To convert an individual contribution into slices, you simply multiply the fair market value of the contribution (less cash payments) by the cash or non-cash multiplier. You subtract cash payments, if any, because cash payments reduce the amount of risk taken. If you pay 100% of the fair market value you shouldn’t have to provide equity at all because you have eliminated the risk.