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:
Individual Share (%)
Total Slices of all Participants
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
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.