{"id":7246,"date":"2021-05-03T16:35:29","date_gmt":"2021-05-03T23:35:29","guid":{"rendered":"https:\/\/maccelerator.la\/?p=7246"},"modified":"2021-05-10T15:19:11","modified_gmt":"2021-05-10T22:19:11","slug":"equity-dilution-in-startups","status":"publish","type":"post","link":"https:\/\/maccelerator.la\/en\/blog\/fundraising\/equity-dilution-in-startups\/","title":{"rendered":"Equity Dilution in Startups"},"content":{"rendered":"\n

Fundraising<\/a> decisions<\/strong> are one of the most important aspects for early-stage founders<\/a><\/strong> when seeking growth<\/a> objectives. How fundraising can affect their company and shareholders isn\u2019t always understood. <\/p>\n\n\n\n

The basic concept is that as a startup<\/a> undergoes a fundraising round<\/strong>, the founder\u2019s ownership percentage is reduced. <\/p>\n\n\n\n

The equity<\/a> dilution has long-term implications that should be taken into consideration early on.<\/p>\n\n\n\n

Equity dilution<\/a> is the decrease in equity ownership that occurs for existing shareholders when a startup issues new shares. <\/p>\n\n\n\n

Founders generally start out as 100% owners of their company. However, every time that capital is raised, the equity owned by the founder is reduced. <\/p>\n\n\n\n

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Founders vs Investors<\/h2>\n\n\n\n

To see how this could work, let\u2019s use the following example: <\/p>\n\n\n\n

A startup with two founders each has a 50% stake<\/strong> in the company, meaning they own 100%. They decide to raise capital with a funding<\/a> round to grow their business further. They decide to raise $2 million at $20 per share with a venture capital firm.
Each founder has a 33% stake in the company, 66% collectively. <\/p>\n\n\n\n

The influx of cash allows a startup to grow further by providing funds to invest in needs such as hiring the right staff, build out the product\/service, and marketing. <\/p>\n\n\n\n

This is a common approach for a startup founder to undergo a series of funding rounds to build the infrastructure necessary for becoming a  viable company in the future. <\/p>\n\n\n\n

Giving up shares in the company in return for investment is generally an unavoidable situation, nor is it something to try to avoid as long as it\u2019s done properly.<\/p>\n\n\n\n

Just a note for early-stage founders. Not every small business is a startup, and fundraising isn’t always the best strategy for a company. If you are not planning to grow quickly, maybe raising capital from investors isn’t a good fit for your business development. If you are raising funds from investors though, understanding the implications with dilution is fundamental. <\/p>\n\n\n\n

\"Founders
Photo by Shannon Rowies.<\/figcaption><\/figure>\n\n\n\n

Just as a startup founder may experience this equity dilution, an investor is susceptible to this as well. In the example shown above, 34%<\/strong> of shares belong to the investors. If the company decides to have another series of fundraising<\/a>, an investor who originally invested in that first round could have their ownership diluted further.\u00a0<\/p>\n\n\n\n

Here\u2019s another general example from the perspective of an investor.<\/strong> <\/p>\n\n\n\n

Let\u2019s say the company issued 10 shares of ownership that equate to 10% ownership that a single investor purchased. An investor in this case would have 10% ownership of the company. Later the company issues 10 new shares which another investor decides to buy. <\/p>\n\n\n\n

There is a total of 20 shares outstanding with a total value of 10% of the company. The new investor owns 5% of the company, as does the original investor. The original investor\u2019s original 10% stake has been diluted as a result of these new shares. Investors especially those who make investments in these early stages generally don\u2019t have control over additional rounds of funding occurs. <\/p>\n\n\n\n

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Why Equity Dilution is Important<\/h2>\n\n\n\n

Getting an influx of money provides a startup with room to grow. The tradeoff is that as a founder, you are giving up your control for the future. Ian Foley<\/a> who worked on several startups including Credit Sesame once remarked, <\/p>\n\n\n\n

\u201cOnly take as much capital as you think you really need.\u201d <\/em><\/p><\/blockquote>\n\n\n\n

This is an important lesson for startup founders to consider when determining how much funds to raise. <\/p>\n\n\n\n

Determining the amount of capital to raise is the most challenging aspect, especially during the early stage startup beginnings. Founders that raise too much are running into the risk<\/a> of unduly giving away a large amount of their company. On the flip side, if you don\u2019t raise enough, you may have to go back to your investors again if you miss out on reaching certain milestones. <\/p>\n\n\n\n

Let\u2019s look at this from the perspective of your investors too.  Some founders may think that because of the basis of dilution, their investors may not be on board with your fundraising goals. At the end of the day, your investors want your business to succeed. <\/p>\n\n\n\n

That\u2019s why they are investing in you in the first place. <\/strong>They believe in you as the founder of the company to the next level because they want to see a return on their investment. <\/p>\n\n\n\n

As a founder, you should have clearly thought out how the effects of dilution will impact your investors. Be prepared to discuss why this dilution is necessary for the future of the business. <\/p>\n\n\n\n

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Forms of Equity Dilution<\/h2>\n\n\n\n

There are a number of different ways that a founder and its investors may experience the effect of equity dilution that should be understood. Too often, when topics around dilution arise, the thoughts that being considered focus on your ownership percentage. <\/p>\n\n\n\n

The dilution that causes a reduction in your ownership percentage is a factor in your long game. However, this is not the same as how each dollar is distributed when there is a payout. <\/p>\n\n\n\n

A new round, issuing shares, and other dilution causing event like this will lower your ownership stake when in terms of:<\/p>\n\n\n\n