equityI see companies having raised $50-100 million over the span of two years and having over 20 investors. How much equity do the original founders of the company typically get to keep upon having done so, and how do they manage to keep that amount?
Further, I understand that their equity retains its value, but I’m still confused: how is it in the founders’ interest to dilute their shares in their own company, other than being the (natural) management team?
TL;DR: How do founders retain equity?
By having an awesome business where everybody wants to invest in making your pre-money evaluation higher.
Some Definitions:
Valuation Types
• Pre-Money: What the company is worth BEFORE any additional capital is invested.
• Post-Money: What the company is worth AFTER additional capital is invested.
You have a pre-money of $4M, raised $1M and your post-money valuation is $5M. Investor gets 20% of your company.
Option Pool
A pool of Units/Shares in the company to be used to attract and incentivize employees. If they are never issued, they just disappear.
• Fully Diluted Ownership Share: Percentage of Ownership if ALL options were issued.
• Undiluted Ownership Share: Percentage of Ownership not counting unissued shares. If the company sold today, this is the current ownership amount.
For simplicity I am leaving option pools out of the calculation. You can expect 5-20% of your shares going in there.
At the founding day:
Cool people, cool idea, no value.
Stark Industries - Total Shares: 1M - Share Value: $0 - Total Value: $0
Stark Industries needs an investment and calculated that they have a pre-valuation of $800K. They are looking for $200K for R&D. Their post-money worth is $1M.
Angel Round:
250k new shares are issued at $0.8 per share
Total Shares: 1.25M - Share Value: $0.8 - Total Value: $1M
Company doing fine, now need some serious investment to build robots and sh*t. Getting an investment of $2m with premoney of $8m and post money valuation of $10m.
Series A VC Round:
Total Shares: 1.56M - Share Value: $6.41 - Total Value: $10m
Great our robots fly and shoot lasers, now we need to mass produce them to fight Loki. Getting an investment of $20m with premoney of $80m and post money valuation of $100m.
Series B VC Round:
Total Shares: 1.95M - Share Value: $51.28 - Total Value: $100m
So you see how the founders get diluted as the company grows. But the main point is you need to be focusing on your shares value. Which is increased by increasing the total value of your company. It is obvious how the founders get richer by producing a valuable company.
Most likely the investors I listed in here won’t be single but multiple firms and people. But it doesn’t matter how many people invest, your company has a pre-money valuation and post-money valuation.
If you have a $19m pre-money at seed stage and are looking for an investment of $1m, you are only going to give 5% of the company.
How to retain equity?
Its all about the pre-money valuation.
To answer the second question, the basic idea is that owning 100% of a $1M business is less interesting than owning 50% of a $100M business.
This makes sense, but let me do a short aside on the unspoken aspect of risk, since it counts as well.
Specifically, the $1M business might be bootstrapped slowly but surely, and be happy existing as what VCs refer to as a lifestyle business, i.e. one that gets by and allows the CEO to live comfortably.
The VC, in contrast, will only invest in companies that can be scaled to something worth their time, and they’ll want you to get there as fast as possible. Doing so can turn a low risk bootstrapped business into a high risk scale-asap business with a ludicrously high burn-rate.
As such, going after investors makes sense for a certain type of business (and founder) only.
As to your first question, related to the percentage the founders (and employees) keep, it depends and varies widely from a company to the next. Good VCs understand that it’s less fun to run a company you don’t own, so will aim for roughly 50/50 at IPO time. But IPOs have occurred with massively different ratios in favor of one or the other side, e.g. Facebook.
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