Many years ago, I was discussing with my father the appropriate chunk of equity to give some new partners in my first startup – they were negotiating for equal ownership. He offered this observation: Only man distributes things evenly – God doesn't give everyone the same slice of pie, why should you – if you put in all the money, you should have the largest ownership stake.
That makes since – but as I interact with many new entrepreneurs, I still encounter those that think/hope they can hold on to their precious equity. It is a rare situation where a founder owns the largest piece of pie by the time the company is sold (if they use outside financing).
Look at this very simple table:
Entity | Founding | Angel | Series A | Series B | Series C |
Founder 1 | 50% | 35% | 21.4% | 11.9% | 5.3% |
Founder 2 | 50% | 35% | 21.4% | 11.9% | 5.3% |
Option Pool | 10% | 10% | 10% | 10% | |
Angels | 20% | 12.2% | 6.8% | 3.0% | |
Series A Group | 35% | 19.4% | 8.6% | ||
Series B Group | 40% | 17.8% | |||
Series C Group | 50% |
There are numerous assumptions with this basic model. I assume that with each round more options are placed into the pool to attract employees. The amount of dilution is not set in stone (green box) – but from where I sit, it's about right +/- a few points either direction. If you need to bring in a CEO expect to give up 5% if it is later in the company life – more if it is earlier (up to 10%) – this may come from the option pool if there are enough shares to accommodate the hire (btw COO 2%-3%, CFO 1% -2%). The investors from one group will usually participate in subsequent rounds to maintain their ownership stake. It is common to get some options from round to round as a reward for a job well done – but usually they do not make up for the dilution from the fundraising.
Dilution and amount raised aren't necessarily linked. Money raised is more a function of the opportunity and investor. A huge opportunity requires an investor that can fund the company to success – a smaller opportunity requires a smaller investor. Each investor, however, needs a piece of the pie that makes sense for their fund. It is unlikely a VC with a large fund will put in a little bit of money early on for a small stake – they need to invest proportionate to their fund size and anticipate future rounds of financing.
So how do you protect your equity? Grow as fast as possible with the least amount of money. If you think you'll need lots of cash – resign yourself to dilution – and raise money when you can. The lowest a founder/CEO will be diluted is around 5% - that is no investor will dilute you to 1% (unless they don't like you) – they will grant options to make your ownership stake interesting to keep you engaged in the business. Other positions will likely fall below the CEO. When I was at Raindance, by the time we went public I had about 4.6%. If you can get to profitability very quickly – do so – it will help with future fundraising, maybe even eliminate the need altogether.
So how do some companies raise gobs of cash with less dilution – it's simple they are having huge success. If you are dominant in your field and you are growing like crazy, you'll be able to give up less equity with each round. If, however, you are doing well but your victory isn't certain –then expect dilution. If you are doing just OK – then it gets harder.
Other ways to protect your ownership: grow slow and use profits to fund expansion, use debt if possible (think credit line, home equity or rich uncle), fewer founders means fewer slices of the pie, go further with less and of course there is always the chance to sell early if the right deal is on the table.
I know there are numerous examples of companies that don't have this type of dilution (those are the ones everyone talks about)– but the bottom line if you aren't on fire – dilution will happen – and from there you'll just have to sell for more to make your piece interesting for you.
