Capital raise dilution and founder equity is commonly misunderstood, getting it wrong can kill investment, restrict your growth and get you kicked out of your own company. It’s where you as a founder exchange equity in your company for cash that you can invest in the business.
You’re going to get diluted the only real question is by how much, which is completely dependent on the amount you are raising and your ability to justify your “perceived valuation”, and the “real valuation” accepted by an investor. For first-time founders this is a new hurdle that requires understanding and planning.
A common problem is founders trying to maintain the maximum amount of equity, this is an incorrect approach because cash is the most valuable resource a startup company can have. Usually this is due to a lack of understanding that all shareholders dilute in all rounds besides the first round. Equity is from the company as a whole not the founders equity position.
In Venture Capital rounds this may not be the case but for this explanation we are taking a simple view.
You must be prepared to exchange equity for cash. Now when I say this I say this within limits, you don’t want to be handing over more than 35% of your company in any round other than an IPO.
Unlike “Dragons Den” and “Shark Tank”, do not give away half of your company right from the outset! Unless of course you’re sharing half of your company with a co-founder, or you have nothing but an idea, then it’s a different scenario.
So let’s assume you’re the sole founder in the company and you need to raise capital, so what’s going to be a reasonable amount of equity dilution?
In my experience it’s reasonable to be handing over anything from 10% to 25% per investment round, in an IPO it can be 30% to 50%.
As long as it’s less than 25% in each capital raise round you should not be too concerned.
Now consider that prior investors are also diluting and your value is increasing in each round, so you’re not giving up as much as you might think.
This is where most founders get it wrong, its the dilution maths, so here’s the common miscalculation.
The company exchanges 25% company equity in three separate rounds of capital raising, then I’m only left with 25% of my company.
Incorrect, you actually have 42.19% equity remaining after three rounds.
Why, because 25% is not from your equity, its from the company as a whole and all prior investors dilute which means you dilute less in each subsequent round.
| Raise Amount | Pre Money Value | Post Money Value | Investors % | Founder % |
| $133,333 | $400,000 | $533,333 | 25% | 75% |
| $666,666 | $2,000,000 | $2,666,666 | 25% | 56.25% |
| $1,333,000 | $4,000,000 | $5,333,000 | 25% | 42.19% |
Now let’s look at another example.
Company “XYZ” has an online platform with software development six months from completion, they need cash to stay on track and avert a disaster.
So the valuation has to be realistic, otherwise it’s going be a really hard sell, investors hate overvalued companies and will deeply questioning your financials.
At this point it’s important you consider the end game which is your final equity position and exit value.
So there are two choices: more capital raises in smaller steps “Staggering” or raise more in less rounds. Each has it’s advantages and disadvantages, and every situation is different, but a staggered capital raise strategy give you more room for mistakes and get you investment more quickly.
In this example we are assuming a staggered capital raise as the company is early phase and has suffered a few setbacks so better to play it safe. There’s nothing stopping the company from adapting its capital raise strategy later.
To estimate simple scenarios on equity dilution and value in every investment round from seed to IPO, or if you hate maths like me download the
“Capital Raising Dilution And Value Calculator”.
These are the starting values in the spreadsheet…
| Capital Raise | Capital Raise | Pre Money Value | Post Money Value | Equity Amount | Founder Equity |
| Seed Round | $100,000 | $500,000 | $500,000 | 20% | 80%. |
| Angel Round | $500,000 | $2,000,000 | $2,500,000 | 20% | 64%. |
| Series A Round | $1,000,000 | $5,000,000 | $5,000,000 | 20% | 51%. |
| Series B Round | $5,000,000 | $20,000,000 | $25,000,000 | 20% | 41%. |
| Series C Round | $15,000,000 | $45,000,000 | $60,000,000 | 20% | 31%. |
| IPO Round | $30,000,000 | $70,000,000 | $100,000,000 | 30% | 22%. |
You can change “Capital Raise” amount and “Pre Money Value” to suit your own circumstances.
In the chart view, its easier to see the decreasing Founder dilution and increasing value.
NOTE: After the IPO round Founders @ 21.5% and $21,504,000
In fact in the last round although the company as a whole diluted 30% the founder only diluted 9%
That’s the impact of equal equity dilution across all shareholders
I always try and make sure my equity dilution on each round is in a target range of 15% to 20%, with a final exit range of 15%-25%.
So diluting your equity position when capital raising is a completely normal thing.
Again it’s important to understand your looking at the endgame here, focus on your final equity position and exit value. That end game when the company valuation is enormous is where you’re actually going to make your money.
Your better to hold 20% of a successful $100 Million company, than 50% of a $20 Million company that was under capitalised with strangled revenue growth.
Remember have the end game in sight, don’t get greedy and don’t be afraid to give up equity, you’re going to have to do it to raise capital for company growth.
PRO TIP:
If your early round values are low consider a staggered capital raise
P.S.
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