Dilution

https://blog.ycombinator.com/dilution/

by firloop • 9 years ago

486 123 9 years ago

blog.ycombinator.com

pdog• 9 years ago

Most founders' instincts seem to be to give too much equity to investors and not enough to employees.

Is this wrong? Investors don't receive anything for their capital but equity. Employees receive income, benefits, etc. that have to be factored into the equation.

anandkulkarni• 9 years ago

In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor.

Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the company, versus your first engineer, which would be more damaging? The investor's money is already in the bank, whereas the engineer will cost time and money to replace, as well as disrupting the ongoing development.

jimmykennedy• 9 years ago

"It's more valuable to have them invested long-term in the company's success." Why? A cash bonus of "If we meet this deadline you will receive $X" is going to increase my productivity much more than "you own 0.01% of an illiquid, unprofitable company". Startup equity is way too abstract for employees to affect their motivation. Peer pressure, mission, pride in work, cash bonuses / raises / promotions are infinitely more impactful.

rqebmm• 9 years ago

I'd argue the better analogy is "If you have a great idea, what's more important to get it to market: your first engineer or your first investor?"

The next is always going to be "well, do I have enough money to pay my engineer?" This is why the investor holds all the cards and therefore gets the best deal up front. Without that up-front money there is no eventual business.

tyre5• 9 years ago

It's absolutely wrong! Employees are the ones who put in the work to actually build the company.

As you said, investors only put in capital (and sometimes advice and/or intros.) Employees work full-time on the company, oftentimes for below-market rates (what they could reasonably assume to make in salary + benefits at larger companies.)

A company at any size is far, far, far more likely to succeed or fail based on its employees than its investors.

idiot_stick• 9 years ago

Employees are the ones who put in the work to actually build the company.

Company and work that, in most cases, wouldn't exist without a capital investment.

maxxxxx3• 9 years ago

Employees also take more risk. Investors just lose money but employees lose years of their career if things go wrong.

nostrademons5• 9 years ago

I think this is saying that founders often underestimate the variance that employees bring to their company's success, and overestimate the variance that an investment round brings.

If you assume that employees are basically fungible and that $100K in salary will buy the same output regardless of who works for you and how motivated they are, then it makes sense to raise $10M rather than $2M, so you can hire 100 person-years of work rather than 20 person-years. VCs become the limiting factor.

If you assume that there are wide varieties in employee output that stem from a.) hiring the right employees b.) into the right roles and c.) compensating them so that they're incentivized to do their best, then it becomes absolutely critical to attract those employees and motivate them. It is unlikely that you will attract these types of employees for a $100K/year salary. It is far more likely that you will attract them with a percent or two of equity that could be worth several million dollars.

In my experience, the latter is a much closer description of reality than the former is.

From the entrepreneur's perspective, what investors or employees "deserve" is irrelevant, what matters is how much of an effect they have on the ability to deliver a good product to a big market. Early employees are in the trenches with you every day; the difference between high effort and low effort from them can make or break the company. Investors give you money and often advice/introductions, but you are one of many investments in their portfolio; they are not going to give you high effort.

bbcbasic• 9 years ago

My understanding is that employees will be paid less than what they could earn elsewhere, so need to be compensated with some upside for that shortfall.

If I were to cut your pay by $100k to join my company, would you say, ah OK but I am still receiving income & benefits, don't worry about it?

If you have to leave your 9-5 to work for my 10-"late" for the same salary, would you want something extra for that, even if it is just a high-EV lotto ticket?

Another argument, made in the article is that if you want to attract the best talent you need to make an attractive offer.

Otherwise why wouldn't the people you want just go work for Google or another startup, or start their own?

CalChris4• 9 years ago

Employees take a risk. First, they don't have to work for your startup. They could go to work for BigCo and have a secure paycheck. Second, they get options for common stock which vest over years. Generally that first year is at will.

birken• 9 years ago

Remember that raising money is not success. Raising huge amounts of money early on is very rarely how companies win (though it is sometimes how companies lose)

I honestly think one of the reasons the company I worked for was successful was our inability to raise money while we were young, which forced a real discipline and creativity for how to do more with less. It also made us skeptical of investors and ensured we didn't base our internal feelings about the company based on what a bunch of incredibly fickle investors thought. This was important both when investors hated us, and perhaps more important when they switched and loved us.

And to the second point, I saw first hand how easy money made one of our competitors so cocky they had no chance of success, and another one got too much money and got distracted spending it all to actually make a core business that made sense.

Money is necessary and important, but having too much of it is also a risk that you need to take seriously.

k__• 9 years ago

Yes, I don't understand the whole investor hype.

I mean, I do contract work with startups and get paid with investor money all the time, so it's good for me.

But I think most investors are a liability.

First you have to make your employees and your customers happy and now you also have to make investors happy? How shoult this be a good thing?

It's hard enough to build products for users I can't directly interact with, why should this equation get another variable :\

marcofloriano2• 9 years ago

Maybe one thing lead to another. By making your customers and employees happy, you make your investors happy.

The money makes sense when you need to scale fast. Specially in the development stage, when you don't make a dime yet.

With the advance of the internet marketing, it's don't make much sense, as you put.

Investors should be moving their money from internet, i think, to AI, Space, Augmented reality and so on. They should fund stuff that is really risky. Turns up ... internet is not risky anymore.

karthikb• 9 years ago

Unless you are independently wealthy or building something that can truly be bootstrapped (no expensive R&D, for example), investors are a necessary constant.

yosefk4• 9 years ago

Counterpoint: if you're running out of money, the next investor you try to raise from is going to be tough to negotiate with. If you have years of runway left, you're in control when talking to investors, when you have 6 months, they're in control. Another point is that when everything comes down crashing, as it did in 2008, and you can't raise money anywhere nor, in many cases, make a profit in the near future since demand for everything also crashes, then if you've squirreled away enough money, you don't have to fire anyone, nor close shop.

This is not to say that too much money can't cause the problems you mentioned. The cure is to keep the money in the bank and not spend it.

All of the above is what my employer did, not my own personal idea. (Also no VCs, these gut the company if it's neither public nor profitable in 5 years, or at least they used to.)

marcofloriano2• 9 years ago

I like your idea (actually i practice it), but your investors aren't putting a lot of money in your hands so you keep it at the bank to them, right? They could do that for themselves.

By experience you don't need years on cash to survive in the long run, discipline and a business that makes sense is way more powerful.

But off course, months of runaway is necessary. More than that is luxury.

pc86• 9 years ago

If you're hemorrhaging money, they're going to be in control regardless of your actual burn rate. Even with years a runway if you're losing money month over month and your runway only gets you 90% to profitability, it doesn't matter if that 90% happens in 2 months or 2 years, it's still going to happen without cash or a change at the company.

sydd• 9 years ago

Agree, I saw a startup where I worked go down because of too much money.

They had a very good seed round and raised $2M. They used this to develop their first product, which did really well. After 2 years we had 50 employees and were breaking even, sometimes even a bit profitable, so we had even some extra in the bank. Obviously such numbers drove investors crazy, and they went to the highest amount they could raise without selling most of the company. So they raised about $20M.

After a few months our product (and our income) started to dwindle (competitors were upping up their game, different platforms became relevant,...), but the founders were very chill about it - I guess because we had enough cash in the bank to run the business for years without firing anyone. But after a year of so the investors started to panic - no wonder since our revenue numbers were in freefall. After another year or so the founders were forced to sell the company for small change compared to what it was valued at its peak.

snarf21• 9 years ago

This is the part I don't understand and am going through now. You raise a ton and get good at spending or you raise minimum and constantly bridge every time growth doesn't match plan, buying time to catch up or tweak.

Why don't investors offer terms that have steps with growth KPIs (ones you can't spend your way to) that give you more money automatically if you make the metrics? As a company you don't have to constantly raise or bridge but you also can't go drop 5M on new offices. You have all the money and runaway you need as long as you hit the milestones. The investors still have all the same upside but less exposure.

I must be missing something I guess. It would solve issue we have at the startup I'm at now though.

alexmingoia• 9 years ago

In other words, companies are taking investment later and later in their lifespan so founders need to be sure thy have some left many years and many rounds after they started. Capital is dirt cheap and desperate for return - and only getting cheaper.

65827• 9 years ago

I think the spectacular real time failure of Uber is going to drive a lot of those valuations down.

CalChris4• 9 years ago

I think you're right but VCs have only themselves to blame for that fiasco.

achou• 9 years ago

"How do I spend this money?"

If you're asking yourself this question, you're not focusing on building your business. How to spend it becomes a distraction.

The converse also happens: for any business problem the easiest solution is to spend money. Leads? Leadgen firm. Hiring? Recruiters. Code? Outsource, or contract out. Testing? you get the picture.

Throwing money at a problem is a short term fix but fails to build competence at doing that thing. The lack of experience weakens your company in the long term. It's organizational muscle that didn't get exercised. It atrophies over time.

This might make sense for certain areas, but having too much money on hand makes it very tempting to solve all problems with this one hammer.

blazespin• 9 years ago

I think something needs to be said about context. Some ventures will be more successful by raising more / diluting more, while others the cash will just hurt. Some examples: hardware plays versus an AI startup.

matchagaucho2• 9 years ago

In every VC pitch I've made in the past 5 years, they have all offered more money than needed/requested.

Maybe I over-corrected by choosing to bootstrap, but you can never own too much of your own company.

In the VC's defense, their funds are increasing at a rate disproportionate to the number of partners available to manage the investments.

VCs simply cannot focus on 100 $1M investments with 5 partners.

gmarx• 9 years ago

Do I understand correctly that every time you have pitched VCs in the past 5 years they wanted to give you money? If pitched to many VCs over the years and never been offered investment. The rest of you make it sound so easy

tyre5• 9 years ago

There is a 100% chance that they did not get money/term sheets from 100% of VCs that they pitched.

Don't feel bad, raising money is really fucking hard, stressful, random, and involves a lot of luck.

matchagaucho2• 9 years ago

Sorry, didn't mean to trivialize the process.

More literally, for the all VC conversations that got past due diligence, the negotiations simply fizzled out.

Dilution was only one of many factors. It is a very hard and grueling process.

lpolovets9• 9 years ago

Caveat: I'm a seed stage VC, so obviously I have a horse in this race.

I don't agree with this advice. Well, in theory, I strongly agree that avoiding excessive dilution is ideal. But the suggested numbers (10% dilution for a seed round) feel very unrealistic to me. It's very hard to get far on that kind of money for a seed stage company. If anything, the proliferation of bridge rounds and seed extensions and series of convertible notes show that even after raising seed rounds, many companies need more capital to get to a series A.

It's also interesting to note that the 10% figure is coming from YC, which takes 7%. That's a considerable amount of dilution, too (and very worth it, IMO).

Finally, I've never been a founder, but I imagine if a company becomes enormous, I'd care less about whether my net worth was $200m or $250m as a founder. So the dilution seems less important than having enough capital for a successful outcome. I'd rather have 60% of a small exit than 80% of a $0 exit.

I do believe in constraints and good cash management, so regardless of how much founders raise, they should be conservative with spend until they have strong product market fit.

lancewiggs2• 9 years ago

We are VC/early stage investors in New Zealand, and give the advice constantly to raise as little as possible at each stage - and plan to get back to cash-flow positive if another round does not turn up. It's a function of our lean investor ecosystem here, but it also creates companies that treasure every dollar and are even more attractive for investors.

lpolovets9• 9 years ago

I think that's a great mindset to have and to encourage. My main argument is that "as little as possible" -- especially in Silicon Valley -- is usually much closer to 20% than 10% dilution at seed. E.g. an FTE salary might be $125k-150k/yr, and selling 10% at a $5m cap gives you enough capital for 3-4 people for a year, which is a very small team and very little time to make enough progress to raise a Series A.

tyre5• 9 years ago

I agree. Ironically, this was the advice we got while going through YC (yours, not Sam's.)

Specifically: don't worry about valuation because success is binary. You either make enough money that you don't care too much about percentage or you make zero dollars in which case you don't care about percentage.

The idea of constraints helping to focus a team sounds true, as long as people have enough to not worry about money. Note that this advice comes from Sam, who literally got scurvy from eating too much Ramen while a founder of Loopt.

ryandrake• 9 years ago

Does anyone else find this binary view of success to be... sad? I guess you could say that if your goal isn't "Uber or bust" then don't take external capital. Is there really no funding available for companies that just want to make relatively safe, modest bets and deliver relatively safe, modest returns?

tbrowbdidnso2• 9 years ago

I will never take startup advice from investors. They care about your company and their money, not you.

Of course they're going to tell you not to worry about giving more of the company away, they don't care who owns it. More money flying around is almost invariably a good thing for early investors.

You don't really need advice about funding from anyone, just look at some successful companies and see what they did. Funding is one of the few aspects where you can mimic your startup idols because it's public info.

The fact is, all the biggest unicorns had enough promise and brains behind them to retain majority ownership, or at least full control well into billion dollar territory. If you're good enough investors will be practically begging to give you their money.

Yeah, so fuck the advice from investors. Make sure you keep as much ownership and control over your company as possible until it's sending people to the moon.

coffeemug• 9 years ago

I imagine if a company becomes enormous, I'd care less about whether my net worth was $200m or $250m as a founder

As an ex-founder I never understood why people make this argument because it's completely symmetric. I.e. I could rephrase it as "I imagine if a company becomes enormous, I'd care less whether my outcome was $200m or $250m as a VC"

I agree with the advice in the article but would phrase it slightly differently -- work hard to structure your company such that you can get away with raising as much as you need and still give away only 10%-15% each round. (Or, yet another way to put it, build a company so successful that you can dictate the terms)

lpolovets9• 9 years ago

People do make that symmetric argument, actually :). A lot of people in the ecosystem, both founders and VCs, will say things like "investors shouldn't be price sensitive, because if you've found the next Uber, it doesn't matter if you get in at a $10m cap or a $15m cap."

3pt14159• 9 years ago

To me it's about the control more than it's about the money. If preferred shares got half the voting rights as common then the difference between a 10% seed and a 15% seed isn't as bad, but after accelerator / angel takes 7%, seed takes 15% and possible bridge + series A takes 30% you're down to raising a series B and admitting that you're no longer in control of the company.

austenallred• 9 years ago

My first reaction was "wow my company must have sucked." And granted on many levels we did (and were never close to being the hottest company in the world), but if I fought for 10% seed dilution I would have been laughed out of the room.

Maybe it's different if you're a shit-hot YC company, but man. I thought you were successful if you stayed below 20% at seed.

lpolovets9• 9 years ago

Yeah, my ballpark estimate from my portfolio (~50 investments in my fund + ~20 personal angel investments) is that 20-25% dilution is common at seed stage. Occasionally it's 15%, which is great. Occasionally you also see 30+%, and that's pretty bad.

yosefk4• 9 years ago

One big problem with dilution isn't that you make less money but that you lose control of the company. And poor decisions by investors are a good contender for the #1 thing killing companies. For a VC this is yet another bet which they don't quite understand or care about, compared to a founder for whom it's the bet, and they understand it and care about it much more. Founders being in control is better than VCs being in control.

codingdave2• 9 years ago

I'd rather have 60% of a small exit than 80% of a $0 exit.

60% is one funding deal away from becoming a minority stake, while 80% leaves room to do another deal while still maintaining control. Money is not the only concern here.

CalChris4• 9 years ago

But he's talking about exit and not control after another round.

Brushfire• 9 years ago

(Hey Leo)

I agree, this is hard to do. Because most investors triangulate on 15-25% per round, and use the amount of money you expect to raise as a way to back into a valuation.

As a founder, the best way to do this in a seed round would be to raise (all or most of) your seed round from Angels, who are more likely to sign off on a note / safe at a specific cap without knowing the total amount raised, and then you can triangulate on 10%.

It's worth noting that this game is even harder outside of the valley, because while operating costs are significantly lower, so are valuations, and most companies will bump into minimum cash needs for 12-18 months.

Sam made a good point: running out of money is way worse than optimizing for your cap table.

Let me make a second point: Optimizing for success is way more important than optimizing your cap table. In other words: If you believe a specific investor meaningfully adds to the probability of a success state for your company, then its probably a good bet even if you are not happy about the dilution.

In order of what you should care about:

1. Not running out of money.

2. Finding people who can be value-add and help you prevent mistakes and find success.

...

3. Dilution (within reason).

Also, you can always recap founders in later stages. It happens.

lpolovets9• 9 years ago

That's a great way to prioritize those three things. Existential risk is always #1.

neom2• 9 years ago

Money is simply wind in the sails.

neom2• 9 years ago

The fact that I got voted down on this just goes to show the level of ability to understand reality HN has. HN is a bubble.

marktangotango• 9 years ago

I didn't down vote, but your comment was banal and didn't add anything to the discussion. HN aspires to a higher level of discourse, as you probably know. Just glanced at your profile, you probably have a lot of insight that everyone would find interesting!

jmspring• 9 years ago

A classic comment from the CEO of a startup I worked at during an all hands after a new round of funding, someone asked about dilution. The CEO (with a straight face) said, "you weren't diluted, the share price increased." The question was from one of the early employees. It was one more item that made a few of us who were already fed up about a few things leave before even vesting.

grosbisou• 9 years ago

Could you link to some resources to help understand this kind of stuff? It's hard to navigate between all the numbers people at startup throw like it's always good things.

For example in your case why was it bullshit? It sounds like you potentially own less but it got more expensive.

e1g2• 9 years ago

why was it bullshit?

It probably was bullshit because to raise money the company will usually create new shares - and doing this will always make all existing shares own a lesser percentage of the company.

Fun example time! Let's consider a company with 100 shares in total (as printed physical IOUs). An early-stage engineer received 1 of those shares, so they own 1% of the company. Fast forward to the next all-hands meeting, and a founder says they just raised a new investment round. Common practice suggests that the new investors just bought 25% of shares/IOUs. But where did these IOUs come from, if there were only 100 and all are distributed already? In essence, the company just printed new ones, much like the government can print new money. In this case the company started with 100 shares, then printed 33 new ones for the new investors, and now those investors own 33/133 shares or ~25% of the company. And our early-stage engineer owns 1/133 shares, or their ownership got "diluted" to 0.7% from 1%. Perhaps. Or perhaps the company printed 500 new shares, and the new investors now own 80% of the business (500/600 shares), and the engineer owns 0.16% instead of 1%. This is what the engineer is asking: "by how much did I get diluted?". The founder is replying "you didn't", which is mathematically impossible if new shares/IOUs were created. Of course now the engineer's 0.7% is probably worth more in $$$, but that wasn't what they asked.

That's under typical conditions, but it's possible that the founder was correct as long as the company did not print new shares. Two examples come to mind: (1) the founders sold some of their own shares to the new investors at a much higher price, thus keeping the total share count at 100 but implicitly increasing the price of the 1 share the engineer holds. This scenario is unlikely because it's seen as a bad signal - the founders are cashing-in and existing the venture. (2) The company had 100 shares, but only distributed 80 of them initially, so the new investors are getting their shares from the remaining unallocated pool. This means the total share count remains at 100, and the engineer still owns 1% with no dilution, and the price just went up and that's it. Having 10-15% unallocated for attracting talent is normal, but having ~25% unallocated for future fund raising is unnecessary complex and highly unusual.

oculusthrift2• 9 years ago

Tangential question: How do founders typically retain control of their company? I've specifically been told that it's wise for one person to own 51pct of the company and be CEO. However, with 20 pct of equity for investors and 10 reserved for future employees, this doesn't seem to leave much for cofounders who are potentially putting as much skin in the game as the CEO.

jacquesm5• 9 years ago

I've specifically been told that it's wise for one person to own 51pct of the company and be CEO.

Well, if that CEO puts up 51% of the capital that might happen. But otherwise the better formula is to be equals as co-founders.

oculusthrift2• 9 years ago

From what I've read, from former ycombinator founders, that if one person isn't in charge then people get stuck in decision paralysis. And that for instance if three people are equal partners, its always a game of alliances and two people ganging up against the other one.

hbhakhra• 9 years ago

That would only happen when you have a line of investors waiting to invest and you can dictate the terms because of your high growth trajectory. In most cases though, it's not going to happen because of the standard numbers outlined in the article.

nostrademons5• 9 years ago

Historically, when this has happened, it's because the founders have managed to build the product & get on the growth trajectory before taking investment. Bill Gates built Altair Basic, sold it to hobbyists, and reinvested the profits to buy MS-DOS and sell it to IBM. Larry & Sergey had a working search engine that was using up half of Stanford's bandwidth before they took their first angel investment. Facebook was a dorm-room project. SnapChat was a final project for a Stanford product-design course and had 100k users before it took investment. The Apple 1 was done in Steve Wozniak's nights & weekends, and had sold out before they took investment for the Apple 2.

If you have a working product and ideally money coming in, the early negotiation leverage changes dramatically. You can skip the seed round entirely, because you've already seeded the project. You can usually get a very good valuation on Series A, since your metrics look great and every VC wants a piece of you. You can negotiate to give away very low equity stakes in later rounds, since at that point you seem like a sure thing.

The flip side is that most side projects don't go anywhere. You need to be both very dedicated and very lucky to strike it big without investment.

onion2k• 9 years ago

You're assuming that all equity is equal. It isn't. For example, shares given to employees are often non-voting. A company could have 99.99% of the equity in non-voting stock, meaning whoever holds the 0.01% that have voting rights controls the company.

When it comes to shares "ownership" does not directly correlate with "control".

amorphid2• 9 years ago

Do startups ever pre-allocate blocks of equity for investors? I understand it's common to carve out N shares for employee options.

Say pre-raise look like this...

- 30% for founders

- 20% for employees

- 50% for future investors

Then when raising initial funds, you sell 20% the total pie (40% of the investor block) of the company to investors, making the share split look like this...

- 30% for founders

- 20% for employees

- 20% for current investors

- 30% for future investors

When an exit occurs, any unallocated shares get split up among the existing shareholders using whatever formula is used to calculate how the money is distributed.

jkarneges3• 9 years ago

I did something like this with our company, but it doesn't really do anything other than make round share counts. All that matters is the proportions between shareholders, not the number of unissued shares.

amorphid2• 9 years ago

Given what you know, would you do it again? My main thinking is that it's simply easier to reason about, especially when discussing the value of shares with non-investors.

sama• 9 years ago

Bug fix: in an earlier version I used 12.5% and 20% as the rough targets for seed and A rounds. Then I decided to switch to 10-15% and 15-25% ranges. Somehow that change only partially got made, indicating 10% and 15-25%. Now it's fixed.

logicallee• 9 years ago

I think it's a bit insensitive not to mention that at the seed stage most companies throughout the world cannot raise any money on any terms, period. (Literally: period.)

This includes companies with revenue and built product.

The rest of the advice is good and interesting - but it really is for companies that can raise in Silicon Valley.

jartelt• 9 years ago

The other consideration with raising a large round is that you are going to have a high valuation. If your company is awesome and growing really fast, this is no problem. However, if you overestimated your market and struggle to grow into that high valuation, you limit your options for a successful exit.

Abundnce10• 9 years ago

Somebody please make this: like TransparentStartup [1] but instead of sharing revenue numbers the startup shares their cap table so that we can see how it changes over time after multiple rounds of fundraising.

I feel like seeing concrete examples of how the founders' share of their company changes based on the size/details of a fundraising round would be super useful for founders as they negotiate funding rounds.

Are there any companies currently sharing these details that I'm not aware of?

[1] http://www.transparentstartups.com/

god_bless_texas• 9 years ago

I would love to see that along with the founder and early employee stakes broken down on the company side. This is all so easy when you read it on various websites and haven't actually done it on your own. Then you get in the driver seat and there's all this crap flying at you that doesn't fall into any one bucket. The guy who is critical to your business doesn't care how much equity he gets. The gal who is not as critical is ready for a cage match. The investor wanting to throw you 5 million makes the offer over a burger and a beer. The guy in the next town over wants pages of documentation for his $20,000.

Kiro• 9 years ago

raise $5 million on a $10 million pre-money valuation (selling 33% of the company to investors)

How do these calculations work?

tyre5• 9 years ago

The pre-money valuation is what you are worth before the investment. So you're saying "we have a company worth $10 million" and the investor is saying "cool, let me give you $5 million."

So now you have $10 million in company plus $5 million in cash, so you are worth $15 million (that's called the post-money valuation.) The investor gets $5m / $15m—33% of the company.

sja• 9 years ago

Worth of company before investor gives company cash (pre-money valuation): $10 million

Worth of company after adding $5 million from investor: $15 million.

Investor now owns $5 million dollars "worth" of a now $15 million company

$5 / $15 = ~33%

antidilution• 9 years ago

Serious question here for people who know about this.

"I have recently seen several examples of companies doing pretty well and going out to raise B rounds with investors already owning 50-60% of the company. In all cases, they are having a tough time."

I know a company in this position. Not quite going out to raise a Series B, but lots of interest from current Series A investors in doubling down (doing an internal growth round).

What's special about this scenario is that the company is profitable and has millions in revenue and grew 1,200% since the Series A investment round just a couple years ago. But because the pre-Series-A financing was at depressed valuations, there is only 30% of stock for the common, and the founders/employees are (rightfully) worried about dilution. The cap table is clean, but the distribution is unfavorable.

In this case, could founders make a reasonable argument that Series A investors should buy out seed investors and angels rather than diluting the common stock holders further? It seems like secondary liquidity for the angels would be attractive to them, and I heard that when offering secondary liquidity for those seed-stage investors, one could do some sort of "stock-cash swap" that avoids dilution of the common. Anyone heard of something like this or have good reading material about it? It seems like an esoteric "third way" between Series A and exit.

bartmancuso• 9 years ago

That seems reasonable if you can find Seed investors willing to sell. The very fact that the new investor wants to put money in at a favorable valuation may be the type of thing that makes the seed investor think "this company might be getting hot" and decide they don't want to sell.

Quanticles• 9 years ago

less dilution = good

money to do stuff = good

wise spending = good

these are all known things, i'm not sure this article actually digs much into how to balance them

SFJulie• 9 years ago

As a former serial startup employee (I used to be young an optimistic) I cannot count the money I earned doing crunch and being underpaid ...

Because I have none of it.

auganov• 9 years ago

Diluting founders' equity is the least important point. A messed up cap table can make your startup uninvestable. It hurts the whole company, not just you, the founder. Which is why you mostly see these deals peddled by VCs without a track record.

Even if you can't get a different deal you might want to pass. There's just no point. Unless all you want is a salary.

equalarrow• 9 years ago

Great post, I love it!

I definitely have an opiniosn.

I've raised money, couldn't raise money, have had friends that couldn't, have ended up having friends slogging through to become millionaires without any vc, and even turned down rounds hoping to get more.

Now when I look back and think "how would I do this now?" I come to two conclusions.

1. If I want to own an idea as a business owner over the long term, then I don't care about investors. This is my Basecamp spidey sense and convictions. My happy path.

2. My idea is great, I need some money. However.... Nowadays I'm thinking along the lines of "long term (hopefully,, but I suspect that most people don't care bs long term"", which is not SV or wall st friendly. I am seriously looking at non-profit.

Uggggh!

I've been through #1 a gazillion times and now, since I have a family and a diff outlook on life, I'm looking longer term.

But, how does the 'family dude' perspective conflict with the Uber perspective?

Growth is the altar that we all kneel to. The Iron Throne. But, it doesn't have to be this way. Granted, we all have Maslow's needs and that varies based on a number of factors (geographic, personal, etc). But in the end, what is our purpose?

Are we here to sustain sexual harassment via star pupils at Uber so they that their 'CEO' can grow? (At the expense of human beings?)

What is the point of growth or even exponential growth? Money? Riches?

Look, I think YC is better than not and I think that we - we tech people - need to lead the way because we 'can'. Thumbs up on riches, algorithms, and technology. These are awesome progressive things!

But, seriously, after going thru the vc grinder, seeing the cap tables of founders and everyone else and then THEN (stupidly) agreeing to this inequity.. Well, the fault is obviously mine but there is is (a lot) of fault with these pump and dump startups.

lmeyerov• 9 years ago

This felt more from a VC perspective than a founder's one..

1. VCs have portfolios and can talk about averages. As a founder, you're dealing with your particular reality, and as startup phases are inherently high variance... your terms will be all over the map, and not driven by your dilution aspirations. Oh, SaaS crashed this quarter and you lost your F100 account? Too bad for you. Bots are in? Sweet!

2. I'm surprised by the dilution percentages here: I'm guessing they're for the top 10% or so, where everything already aligned anyway. Likewise, I'd expect it for something like a SaaS snack boxes -- stuff where averages and predictability make sense from day 1, not crazy bumpy tech etc. Otherwise, for example, VCs will fight HARD for their % minimums. So, 10-15% sounds like one VC at their absolute bottom... and therefore not normal.

3. 7% might be what accelerators converged on... but that's high compared to F&F, angels, & specialized advisors in your field (vs "startups").

dandare• 9 years ago

Am I the only one who cringes when entrepreneur uses the amount of raised money to introduce/describe himself?

"...during my career I have raised $100 million..."

Yeah? And how much value did you create?

Dilution

Related Stories