How much do founders get diluted through exit?
Founders often ask me, "If I own X% after my first investment round, how much will I be diluted through financings until exit?". A follow-on question is: "How much option reload will I get to compensate for that dilution?" There are rules of thumb but there is no good data about what happens to common stock.
So, I wrote a little survey. http://tinyurl.com/d9afsy Share your story. I'll publish the summary data on my blog http://simeons.wordpress.com and will send an update to everyone.
Answers (11)
John S. R.
Hallym University
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Good day Simeon,
You also might want to check out Paul Graham, SD Forum and/or VLAB as possible (networking) resources.
Regards,
John S. Rajeski
Links:
Neil G.
Corporate Finance and Strategy Consultant
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A provocative question and I look forward to seeing the data. I'm wondering what the diversion of circumstance might be. A founder's beginning equity is diluted with every subsequent stock sale or grant. But options relate to compensation and not ownership. A founder retaining the CEO role might expect significant option grants vs. a founder in a less significant future role or no role at all.
Marco K.
Creative UX guy, frontend dev. Maker- hacker geek father of two pretty girls. On the lookout for a new career challenge.
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It depends I suppose. I think one can expect to 'lose' 75/80 percent ownership.
I am very curious to know the outcome of the survey.
Marco Kotrotsos
http://incredicorp.com
Stephen K.
Connector-In-Chief, Business Development Executive, Capital Markets Professional, Rainmaker
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The answer is "as much as it takes." I try to help entrepreneurs understand a basic concept (and a related misconception) regarding dilution. Example: a company founder trades let's say 10% of his (for the time being) worthless shares for, say, $100,000 in cash from an investor. The investor now owns just 10% of the $100,000 in economic value of the company - the $100,000 HE just contributed. Who is the one being diluted? In terms of real economic dilution? The new investor, not the founder.
Yes, the founder suffers "percentage dilution" but a percentage of what? Without capital such a discussion has no meaning. Suffer percentage dilution he will, and how much is determined by his effectiveness as a steward of the capital he raises and the value he creates in the business.
Steve Case owned only 1% of AOL when it was sold to Time Warner and Bill Gates owns less than a third of Microsoft. So how much "dilution" should an entrepreneur be prepared to accept until exit? As much as it takes to execute the plan through to the end game.
Lisa A.
Founder and President at APPCityLife™, Inc.
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There's no set answer. Dilution depends directly on how much financing is needed and secured before exit is possible. Exit too soon and the valuation is likely too low, even if the dilution isn't. Make faulty premises which don't pan out, and the exit could be worthless, no matter what the rate of dilution. The trick is to negotiate the least amount of investing to grow the business into a viable entity so that a profitable exit is possible. For some markets that's 20% by exit, others it's 1% and on occasion much higher.
Jonathan W.
Taylor English Duma LLP
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There is no set answer, of course. But the typical startup will sell 30 or 40% of its equity in its Series A round after giving 10% to the founding management team. Subsequent equity rounds (assuming the startup is successfull) will have roughly 30% ro 40% dilution in each round. If it takes 3 or four rounds of equity before the founder sees a complete exit, the founder is probably reduced to 10% or 20%
The true answer to your question is that "it depends", on a wide variety of factors. There is no one answer. In addition, valuations have tanked everywhere affecting any newly negotiated terms. Whatever may have been true in Silicon Valley two years no longer applies. Then there is the "what's hot!" factor which changes the equation in the opposite direction. Other small business situations without sophisticated advisors and tools, are completely separate case, at the mercy of whomever may have the upper hand in negotiation. I have had two equally qualified advisors/valuators with diametrically opposite views on the value of my business.
Jof W.
Owner of The Shilling Group
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I'm really interested to see the output of your survey - although as many have pointed out here circumstances must vary significantly.
Also one wonders what the play off between the dilution and the increase in share value bought through additional investment is (e.g. I dilute by x% to raise capital but increase company revenue and potential exit by y% as a result).
I'll keep an eye on your blog.
Rick C.
Business structure expert
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This is not a new question. I regularly answered it for founders, employees, and even angel investors. Everyone is concerned about "dilution" without really knowing what it is.
Short answer is that founders need to focus on economics and increasing the value of their companies. Dilution of ownership is a red herring that has distracted many founders, engineers, employees, and angel investors.
I linked to an expanded explanation on my personal blog with an example of venture math.
As a final thought, founders should realize that they can model the equity budget for their company just as they model cash items such as revenue, COGS, and SG&A. Good outside general counsel can help walk them through these items.
Links:
There used to be a "Rule of Five" that people counted off on their fingers in Silicon Valley -- with outside investors taking 3/5, the equity incentive pool taking 1/5 and founders' retaining 1/5 at exit. An expectation of being diluted down to 20% at exit seems consistent with other posted answers, but experience shows individual results vary.
Tim S.
Experienced Stamping Entrepreneur
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potentially 100% if the investors have preferred stock AND your exit is at or lower than the agreed minimum return. your shares are effectively worthless in this scenario.
