One of the areas I like to help entrepreneurs understand is how equity dilution works with each round of financing. A general rule of thumb is 30-40% dilution with each round (e.g. 30% for investors and 10% for a new employee option pool) such that founders usually have between 4 and 15% at time of IPO (see Founder Equity of Ownership at Time of IPO).
For simple math, let’s say an entrepreneur has 100% of the business. Here’s how the dilution might work, assuming 35% dilution in each round:
- After round 1 – 65%
- After round 2 – 42%
- After round 3 – 28%
So, after three rounds of financing, an entrepreneur would have 72% less equity (28% of the original equity).
Entrepreneurs would do well to understand how dilution works and to plan accordingly.
What else? What are some more thoughts on equity dilution over multiple rounds?
4 thoughts on “Plan for Equity Dilution Over Multiple Rounds”
THANK YOU Your information provided on Company dilution information is priceless. Some 22y back I was the Licensed Securities and Investment Dealer with Australian- ASIC and it was my job to explain equity dilution in so many stages prior IPO or just as private Co. Most clients wouldn’t understand, wouldn’t learn or change they perceived know, would go all funny and possessive, go greedy and hold back for all the wrong reasons and ultimately fail. I wish people read what you write as every one of your posts is a GEM and free standing for picking. Live long and prosper GURU
Great topic. Another good explanation of the process was shared by the good folks at Khan Acadamy. Salman Khan shares a series of videos on You Tube non-finance people can understand : https://www.youtube.com/watch?v=8OCjwBkMJ_E&list=PL7AF26EC4A1C8D2D1
One way to preserve more ownership at each stage is to use thoughtfully structured debt capital to extend runway between rounds of equity. All things being equal, the extra 6 months between rounds should lead to a higher premoney valuation at each funding, so, by example, founders might ultimately own more of the company at IPO or exit. If you can preserve 5% ownership prior to exit, that can mean millions to founders. Debt partner selection is important. With extended draw windows, you want to make sure the debt is available when you need it
Always a key area often misunderstood. 10% of something is better than 100% of nothing!