Sell 20% of the Equity Per Round of Investment

Back when we tried to raise venture money for Pardot in late 2009, we reached the term sheet stage with a number of investors. One of the investors that we talked to really wanted to invest $5 million in the company at a $7 million pre-money for a post-money valuation of $12 million. Divide 5 into 12 and you get 42% — the investor wanted to buy 42% of the business as our Series A round. After building a spreadsheet of different scenarios, especially taking into account the growth rate at the time, it was clear that we were better off not raising money and growing organically. Selling 42% of the business with our first round of financing didn’t make sense.

After talking to other entrepreneurs and reading about best practices online, my advice to entrepreneurs is to not sell more than 20% of the business per round, with 25% OK on occasion, if needed. The biggest reason why is that it’s likely there will be more rounds of financing in the future, and each round compounds the dilution to the entrepreneurs. Here’s how four rounds of financing works out selling 20% each time:

  • Round 1 – 80% non-investors and 20% investors
  • Round 2 – 60% non-investors and 40% investors
  • Round 3 – 40% non-investors and 60% investors
  • Round 4 – 20% non-investors and 80% investors
  • Note: Investor ownership will be slightly reduced by new stock option plans as well as pro-rata non participation

If the amount the investors buy each time increases to 30% or 35%, you can see how little the non-investors have at the end. Now, if the company sells for a billion dollars, everyone is happy. In reality, most exits are for less than $50 million, making it ideal for entrepreneurs to minimize the amount of dilution for each round of funding knowing that most venture-backed startups raise multiple rounds.

What else? What are some more thoughts on the idea that entrepreneurs should sell roughly 20% of the equity per round of investment?

3 thoughts on “Sell 20% of the Equity Per Round of Investment

  1. Think it is a great advice to not give up more than 20% of your company but in practice the guys on the other side of the table might not think much of that concept. Back in the day when I was at ATDC seeing lots of deals it seemed like they always ended up between 25% and 33% post money. Granted, valuations have headed north since then but if all entrepreneurs limit the amount of dilution they are willing to accept to 20% a lot of them won’t be raising money. Which might be the better thing to do.

  2. Don’t assume equity is the right source of capital. On a spectrum of cost and risk Equity is the highest cost and highest risk since you give up both ownership and control. The cheapest and lowest risk source of capital is cash flow from operations. Why don;t most of us use that – because we are busy lending it to our customers for free – many small businesses have 3-4 years of earnings tied up in AR! Free that up and consider various debt structures before you give up equity.

  3. Most people Overestimate the amount of capital needed to start a business but Underestimate the amount of capital needed to scale a business. It has never been easier to start a business and it has never been harder to scale. So try and fund your start-up and save raising equity for you scale-up!

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