David Cummings on Startups

Dilution With Every Round of Funding

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David Cummings

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Every time a startup raises money there’s a parade of announcements and media coverage. Raising money isn’t a sign of inevitable success, yet it’s treated as one of the ultimate achievements. For the entrepreneurs and employees, a round of funding results in dilution. And, more and more rounds of funding equals more and more dilution.

Here are a few thoughts on dilution and funding:

  • Dilution, of course, depends on amount of money raised and pre-money valuation (the amount the company is valued at before the money is invested)
  • Equity isn’t static as stock options can be granted multiple times (e.g. existing options might be diluted by a new round of funding but could be partially off-set by the granting of additional options)
  • As a percentage, dilution is often in the 20-50% range, depending on how well the startup is performing and how many investors competed to win the business
  • Companies on the hyper growth track often raise a tremendous amount of money, and dilution is a normal part of the process

Whenever funding, and fundraising is mentioned, dilution should also come to mind as the two go hand in hand.

What else? What are some other thoughts on dilution with every round of funding?

Comments

4 responses to “Dilution With Every Round of Funding”

  1. Ron Stebenne Avatar
    Ron Stebenne

    Question: Is it better to bootstrap and work your butt off whenever possible to build a start-up or is it best to infuse funds using outside investment to ramp up sooner than later? By bootstrapping only, are you giving up the bragging rights for the ‘ultimate achievement’ and a big next step to development?

    Reply
  2. Sanford Avatar
    Sanford

    I don’t have experience in making convertible loans to start-ups but it seems to me, that a loan might be a better deal to the investor than the investor investing in a series A round. The lender could secure the intellectual property as collateral. so, if / when the start-up runs out of money, the company founders are going to be a lot more beholden to the lender as opposed to the series A investor. it would seem that the lender would then be in the driver’s seat to dictate the terms on the next round of financing. plus, the convertible loan could be converted to stock at a more favorable valuation down the road (as opposed to a series A evaluation that is likely going to result in subsequent dilution).

    Reply
  3. Michael Ostendorff Avatar
    Michael Ostendorff

    Some excellent data on dilution available at https://vcexperts.com. We track the actual deal terms (liquidation preferences, anti-dilution provisions, etc.), as well as the valuations for thousands of venture funded companies based in the U.S.;

    Reply
  4. stephenfleming Avatar
    stephenfleming

    Keep in mind that you ALSO need to plan for additional dilution as you create and (later) grow your employee stock option pool (or equivalent in 83(b) restricted stock). No, it’s not a legal requirement. But if you don’t do it, your employees are working for straight salary. You don’t want those employees.

    Reply

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