
Dilution - firloop
https://blog.ycombinator.com/dilution/
======
birken
> Remember that raising money is not success. Raising huge amounts of money
> early on is very rarely how companies win (though it is sometimes how
> companies lose)

I honestly think one of the reasons the company I worked for was successful
was our inability to raise money while we were young, which forced a real
discipline and creativity for how to do more with less. It also made us
skeptical of investors and ensured we didn't base our internal feelings about
the company based on what a bunch of incredibly fickle investors thought. This
was important both when investors hated us, and perhaps more important when
they switched and loved us.

And to the second point, I saw first hand how easy money made one of our
competitors so cocky they had no chance of success, and another one got too
much money and got distracted spending it all to actually make a core business
that made sense.

Money is necessary and important, but having too much of it is also a risk
that you need to take seriously.

~~~
yosefk
Counterpoint: if you're running out of money, the next investor you try to
raise from is going to be tough to negotiate with. If you have years of runway
left, you're in control when talking to investors, when you have 6 months,
they're in control. Another point is that when everything comes down crashing,
as it did in 2008, and you can't raise money anywhere nor, in many cases, make
a profit in the near future since demand for everything also crashes, then if
you've squirreled away enough money, you don't have to fire anyone, nor close
shop.

This is not to say that too much money can't cause the problems you mentioned.
The cure is to keep the money in the bank and not spend it.

All of the above is what my employer did, not my own personal idea. (Also no
VCs, these gut the company if it's neither public nor profitable in 5 years,
or at least they used to.)

~~~
marcofloriano
I like your idea (actually i practice it), but your investors aren't putting a
lot of money in your hands so you keep it at the bank to them, right? They
could do that for themselves.

By experience you don't need years on cash to survive in the long run,
discipline and a business that makes sense is way more powerful.

But off course, months of runaway is necessary. More than that is luxury.

~~~
_yosefk
Investors put money in the craziest places, surely there's a public story
stock right now that you think is inflated beyond belief and yet it trades at
the price it does. It follows that investors will do crazier things than give
you money to keep in the bank if you persuade them.

You tell them point blank, "we're hoping to make it big this year, but we
aren't taking any risks and we're gonna keep enough cash in the bank for the 3
next years. If you don't like this plan, fine, you're missing a chance to buy
a stock that's gonna shoot up 10x and here's why", and they buy your pitch,
they're gonna beg you to take their money.

I'm not saying I can do this, I'm saying people exist who can, and there are
markets where things are measured in years, and so you might want more runway
because your progress is way slower than that of a YC-backed Internet monopoly
wannabe.

By the way, MIPS Technologies was killed by genius investors who said "give us
your $100+ million in cash or invest it" and a genius CEO who said "fine, you
ain't gettin' nothin', I'm buying Chip Idea." It turned out that they didn't
know how to run Chip Idea and ran it into the ground, and now they had neither
money in the bank nor anything to show for it. This drove the company value
down so much that Imagination bought it for $60 million (the patents were sold
to a big CPU cartel for another $500 million, perhaps unfortunately as genius
investors did not get quite the punishment they needed to learn anything.)

A CEO capable of persuading the board of directors to keep the money in the
bank would have done better.

~~~
posterboy
>you're missing a chance to buy a stock that's gonna shoot up 10x and here's
why

that's not a positive pitch. The message sticks, whether you try to negate it
or not, if resonating with expectation.

------
lpolovets
Caveat: I'm a seed stage VC, so obviously I have a horse in this race.

I don't agree with this advice. Well, _in theory_ , I strongly agree that
avoiding excessive dilution is ideal. But the suggested numbers (10% dilution
for a seed round) feel very unrealistic to me. It's very hard to get far on
that kind of money for a seed stage company. If anything, the proliferation of
bridge rounds and seed extensions and series of convertible notes show that
even after raising seed rounds, many companies need more capital to get to a
series A.

It's also interesting to note that the 10% figure is coming from YC, which
takes 7%. That's a considerable amount of dilution, too (and very worth it,
IMO).

Finally, I've never been a founder, but I imagine if a company becomes
enormous, I'd care less about whether my net worth was $200m or $250m as a
founder. So the dilution seems less important than having enough capital for a
successful outcome. I'd rather have 60% of a small exit than 80% of a $0 exit.

I do believe in constraints and good cash management, so regardless of how
much founders raise, they should be conservative with spend until they have
strong product market fit.

~~~
tyre
I agree. Ironically, this was the advice we got while going through YC (yours,
not Sam's.)

Specifically: don't worry about valuation because success is binary. You
either make enough money that you don't care too much about percentage or you
make zero dollars in which case you don't care about percentage.

The idea of constraints helping to focus a team sounds true, as long as people
have enough to not worry about money. Note that this advice comes from Sam,
who literally got scurvy from eating too much Ramen while a founder of Loopt.

~~~
ryandrake
Does anyone else find this binary view of success to be... sad? I guess you
could say that if your goal isn't "Uber or bust" then don't take external
capital. Is there really no funding available for companies that just want to
make relatively safe, modest bets and deliver relatively safe, modest returns?

~~~
tyre
You don't have to do Uber or bust, but don't ask for venture money without
going for venture returns.

I do agree that there is a market opportunity to fund $50m/year businesses,
but that's not what VCs are for.

VCs: Invest in 100 companies, 90 fail, 5 return capital, 3 return 10x, 2
return 100x | 2.35x return on capital over a 10 year period (hopefully)

Index fund: 6% yearly return | 1.79x return on capital over 10 year period

Traditional small business loans average 6-9% APR and have a higher failure
rate than an index fund but lower than an index fund. Unfortunately, for
startups, they require collateral and/or historical financials.

~~~
tbrowbdidnso
I never understood this logic. Investors want unicorns but it's not like
they're going to hate you for only giving them a 5x ROI.

Most startups either fail or become small businesses. Investors are giving you
money to fund a business that you own. Depending on the terms you can, and
should, use that money for whatever you want.

Its the investors problem if 5x returns aren't good enough, not yours. Does
the bank call you to complain that your mortgage interest rate is too low? No.
They gave you the loan with what they thought was reasonable terms at the
time. It's not your fault they gave you the money too easily.

You should be focused 100% on building a successful sustainable business.
Investors can fuck right off if they push for risks that could turn their 5x
return into 0.

~~~
nostrademons
That requires that you have board control. If investors control the board and
you tell them to fuck right off, you will quickly find yourself out of a job.

~~~
syllogism
Board control isn't the problem at seed. You'll usually have board control.
But if you need another round of funding, the investors control the company.

If your seed investors are "name brand", and they pass and say, "Ah yes,
they're very nice guys. Wonderful conscience, very punctual. Unfortunately I
can't follow on, my capital's already allocated. I wish them luck.", you'd
better have a plan for profitability.

------
achou
"How do I spend this money?"

If you're asking yourself this question, you're not focusing on building your
business. How to spend it becomes a distraction.

The converse also happens: for any business problem the easiest solution is to
spend money. Leads? Leadgen firm. Hiring? Recruiters. Code? Outsource, or
contract out. Testing? you get the picture.

Throwing money at a problem is a short term fix but fails to build competence
at doing that thing. The lack of experience weakens your company in the long
term. It's organizational muscle that didn't get exercised. It atrophies over
time.

This might make sense for certain areas, but having too much money on hand
makes it very tempting to solve all problems with this one hammer.

------
Abundnce10
Somebody please make this: like TransparentStartup [1] but instead of sharing
revenue numbers the startup shares their cap table so that we can see how it
changes over time after multiple rounds of fundraising.

I feel like seeing concrete examples of how the founders' share of their
company changes based on the size/details of a fundraising round would be
super useful for founders as they negotiate funding rounds.

Are there any companies currently sharing these details that I'm not aware of?

[1] [http://www.transparentstartups.com/](http://www.transparentstartups.com/)

~~~
god_bless_texas
I would love to see that along with the founder and early employee stakes
broken down on the company side. This is all so easy when you read it on
various websites and haven't actually done it on your own. Then you get in the
driver seat and there's all this crap flying at you that doesn't fall into any
one bucket. The guy who is critical to your business doesn't care how much
equity he gets. The gal who is not as critical is ready for a cage match. The
investor wanting to throw you 5 million makes the offer over a burger and a
beer. The guy in the next town over wants pages of documentation for his
$20,000.

------
antidilution
Serious question here for people who know about this.

"I have recently seen several examples of companies doing pretty well and
going out to raise B rounds with investors already owning 50-60% of the
company. In all cases, they are having a tough time."

I know a company in this position. Not quite going out to raise a Series B,
but lots of interest from current Series A investors in doubling down (doing
an internal growth round).

What's special about this scenario is that the company is profitable and has
millions in revenue and grew 1,200% since the Series A investment round just a
couple years ago. But because the pre-Series-A financing was at depressed
valuations, there is only 30% of stock for the common, and the
founders/employees are (rightfully) worried about dilution. The cap table is
clean, but the distribution is unfavorable.

In this case, could founders make a reasonable argument that Series A
investors should buy out seed investors and angels rather than diluting the
common stock holders further? It seems like secondary liquidity for the angels
would be attractive to them, and I heard that when offering secondary
liquidity for those seed-stage investors, one could do some sort of "stock-
cash swap" that avoids dilution of the common. Anyone heard of something like
this or have good reading material about it? It seems like an esoteric "third
way" between Series A and exit.

~~~
bartmancuso
That seems reasonable if you can find Seed investors willing to sell. The very
fact that the new investor wants to put money in at a favorable valuation may
be the type of thing that makes the seed investor think "this company might be
getting hot" and decide they don't want to sell.

------
jmspring
A classic comment from the CEO of a startup I worked at during an all hands
after a new round of funding, someone asked about dilution. The CEO (with a
straight face) said, "you weren't diluted, the share price increased." The
question was from one of the early employees. It was one more item that made a
few of us who were already fed up about a few things leave before even
vesting.

~~~
grosbisou
Could you link to some resources to help understand this kind of stuff? It's
hard to navigate between all the numbers people at startup throw like it's
always good things.

For example in your case why was it bullshit? It sounds like you potentially
own less but it got more expensive.

~~~
e1g
>why was it bullshit?

It _probably_ was bullshit because to raise money the company will usually
create new shares - and doing this will always make all existing shares own a
lesser percentage of the company.

Fun example time! Let's consider a company with 100 shares in total (as
printed physical IOUs). An early-stage engineer received 1 of those shares, so
they own 1% of the company. Fast forward to the next all-hands meeting, and a
founder says they just raised a new investment round. Common practice suggests
that the new investors just bought 25% of shares/IOUs. But where did these
IOUs come from, if there were only 100 and all are distributed already? In
essence, the company just printed new ones, much like the government can print
new money. In this case the company started with 100 shares, then printed 33
new ones for the new investors, and now those investors own 33/133 shares or
~25% of the company. And our early-stage engineer owns 1/133 shares, or their
ownership got "diluted" to 0.7% from 1%. Perhaps. Or perhaps the company
printed 500 new shares, and the new investors now own 80% of the business
(500/600 shares), and the engineer owns 0.16% instead of 1%. This is what the
engineer is asking: "by how much did I get diluted?". The founder is replying
"you didn't", which is mathematically impossible if new shares/IOUs were
created. Of course now the engineer's 0.7% is probably worth more in $$$, but
that wasn't what they asked.

That's under typical conditions, but it's possible that the founder _was_
correct as long as the company did not print new shares. Two examples come to
mind: (1) the founders sold some of their own shares to the new investors at a
much higher price, thus keeping the total share count at 100 but implicitly
increasing the price of the 1 share the engineer holds. This scenario is
unlikely because it's seen as a bad signal - the founders are cashing-in and
existing the venture. (2) The company had 100 shares, but only distributed 80
of them initially, so the new investors are getting their shares from the
remaining unallocated pool. This means the total share count remains at 100,
and the engineer still owns 1% with no dilution, and the price just went up
and that's it. Having 10-15% unallocated for attracting talent is normal, but
having ~25% unallocated for future fund raising is unnecessary complex and
highly unusual.

------
alexmingoia
In other words, companies are taking investment later and later in their
lifespan so founders need to be sure thy have some left many years and many
rounds after they started. Capital is dirt cheap and desperate for return -
and only getting cheaper.

------
oculusthrift
Tangential question: How do founders typically retain control of their
company? I've specifically been told that it's wise for one person to own
51pct of the company and be CEO. However, with 20 pct of equity for investors
and 10 reserved for future employees, this doesn't seem to leave much for
cofounders who are potentially putting as much skin in the game as the CEO.

~~~
jacquesm
> I've specifically been told that it's wise for one person to own 51pct of
> the company and be CEO.

Well, if that CEO puts up 51% of the capital that might happen. But otherwise
the better formula is to be equals as co-founders.

~~~
oculusthrift
From what I've read, from former ycombinator founders, that if one person
isn't in charge then people get stuck in decision paralysis. And that for
instance if three people are equal partners, its always a game of alliances
and two people ganging up against the other one.

~~~
jacquesm
You are conflating ownership and the role of a CEO. Technically the CEO does
not have to hold equity at all (and this is in fact common in many older
family owned companies).

Decision paralysis is more a function of not having a clear path forward or
having founders without aligned goals than anything else and those are serious
problems that need to be dealt with but they do not need to be dealt with on
an equity level.

It's much more to do with knowing which role fits you best.

Keep in mind that the CEO functions at the pleasure of the board if you have
one and the stockholders if you do not and unless you plan on doing stuff that
will go directly against the interest of other shareholders having control is
rarely if ever important.

 _Far_ more important than the CEO having a controlling percentage of the
equity is that the _founders_ have a controlling percentage (and if possible,
a supermajority depending on your articles of incorporation and shareholder
agreements and whether or not you have more than one class of stock).

------
lmeyerov
This felt more from a VC perspective than a founder's one..

1\. VCs have portfolios and can talk about averages. As a founder, you're
dealing with your particular reality, and as startup phases are inherently
high variance... your terms will be all over the map, and not driven by your
dilution aspirations. Oh, SaaS crashed this quarter and you lost your F100
account? Too bad for you. Bots are in? Sweet!

2\. I'm surprised by the dilution percentages here: I'm guessing they're for
the top 10% or so, where everything already aligned anyway. Likewise, I'd
expect it for something like a SaaS snack boxes -- stuff where averages and
predictability make sense from day 1, not crazy bumpy tech etc. Otherwise, for
example, VCs will fight HARD for their % minimums. So, 10-15% sounds like one
VC at their absolute bottom... and therefore not normal.

3\. 7% might be what accelerators converged on... but that's high compared to
F&F, angels, & specialized advisors in your field (vs "startups").

------
matchagaucho
In every VC pitch I've made in the past 5 years, they have all offered more
money than needed/requested.

Maybe I over-corrected by choosing to bootstrap, but you can never own too
much of your own company.

In the VC's defense, their funds are increasing at a rate disproportionate to
the number of partners available to manage the investments.

VCs simply cannot focus on 100 $1M investments with 5 partners.

~~~
gmarx
Do I understand correctly that every time you have pitched VCs in the past 5
years they wanted to give you money? If pitched to many VCs over the years and
never been offered investment. The rest of you make it sound so easy

~~~
matchagaucho
Sorry, didn't mean to trivialize the process.

More literally, for the all VC conversations _that got past due diligence_ ,
the negotiations simply fizzled out.

Dilution was only one of many factors. It _is_ a very hard and grueling
process.

------
sama
Bug fix: in an earlier version I used 12.5% and 20% as the rough targets for
seed and A rounds. Then I decided to switch to 10-15% and 15-25% ranges.
Somehow that change only partially got made, indicating 10% and 15-25%. Now
it's fixed.

------
logicallee
I think it's a bit insensitive not to mention that at the seed stage most
companies throughout the world cannot raise any money on any terms, period.
(Literally: period.)

This includes companies with revenue and built product.

The rest of the advice is good and interesting - but it really is for
companies that can raise in Silicon Valley.

------
dandare
Am I the only one who cringes when entrepreneur uses the amount of raised
money to introduce/describe himself?

"...during my career I have raised $100 million..."

Yeah? And how much value did you create?

------
Quanticles
less dilution = good

money to do stuff = good

wise spending = good

these are all known things, i'm not sure this article actually digs much into
how to balance them

------
SFJulie
As a former serial startup employee (I used to be young an optimistic) I
cannot count the money I earned doing crunch and being underpaid ...

Because I have none of it.

------
jartelt
The other consideration with raising a large round is that you are going to
have a high valuation. If your company is awesome and growing really fast,
this is no problem. However, if you overestimated your market and struggle to
grow into that high valuation, you limit your options for a successful exit.

------
equalarrow
Great post, I love it!

I definitely have an opiniosn.

I've raised money, couldn't raise money, have had friends that couldn't, have
ended up having friends slogging through to become millionaires without any
vc, and even turned down rounds hoping to get more.

Now when I look back and think "how would I do this now?" I come to two
conclusions.

1\. If I want to own an idea as a business owner over the long term, then I
don't care about investors. This is my Basecamp spidey sense and convictions.
My happy path.

2\. My idea is great, I need some money. However.... Nowadays I'm thinking
along the lines of "long term (hopefully,, but I suspect that most people
don't care bs long term"", which is not SV or wall st friendly. I am seriously
looking at non-profit.

Uggggh!

I've been through #1 a gazillion times and now, since I have a family and a
diff outlook on life, I'm looking longer term.

But, how does the 'family dude' perspective conflict with the Uber
perspective?

Growth is the altar that we all kneel to. The Iron Throne. But, it doesn't
have to be this way. Granted, we all have Maslow's needs and that varies based
on a number of factors (geographic, personal, etc). But in the end, what is
our purpose?

Are we here to sustain sexual harassment via star pupils at Uber so they that
their 'CEO' can grow? (At the expense of human beings?)

What is the point of growth or even exponential growth? Money? Riches?

Look, I think YC is better than not and I think that we - we tech people -
need to lead the way because we 'can'. Thumbs up on riches, algorithms, and
technology. These are awesome progressive things!

But, seriously, after going thru the vc grinder, seeing the cap tables of
founders and everyone else and then THEN (stupidly) agreeing to this
inequity.. Well, the fault is obviously mine but there is is (a lot) of fault
with these pump and dump startups.

------
65827
I think the spectacular real time failure of Uber is going to drive a lot of
those valuations down.

~~~
CalChris
I think you're right but VCs have only themselves to blame for that fiasco.

------
amorphid
Do startups ever pre-allocate blocks of equity for investors? I understand
it's common to carve out N shares for employee options.

Say pre-raise look like this...

\- 30% for founders

\- 20% for employees

\- 50% for future investors

Then when raising initial funds, you sell 20% the total pie (40% of the
investor block) of the company to investors, making the share split look like
this...

\- 30% for founders

\- 20% for employees

\- 20% for current investors

\- 30% for future investors

When an exit occurs, any unallocated shares get split up among the existing
shareholders using whatever formula is used to calculate how the money is
distributed.

~~~
jkarneges
I did something like this with our company, but it doesn't really do anything
other than make round share counts. All that matters is the proportions
between shareholders, not the number of unissued shares.

~~~
amorphid
Given what you know, would you do it again? My main thinking is that it's
simply easier to reason about, especially when discussing the value of shares
with non-investors.

~~~
jkarneges
I wouldn't preallocate for investors. It's too unpredictable. Employees, sure.

Is it that you want to be able to say to your team members, "you have X% in
the worst case" ? I don't think it's practical to make such a statement if
you're going down a fundraising path. At best you might be able give a near
term worst case, based on the next round or two (e.g. apply the high side of
Sam's seed/A dilution ranges). It's all guesswork though, and even with a
preallocation you might need to exceed it.

------
auganov
Diluting founders' equity is the least important point. A messed up cap table
can make your startup uninvestable. It hurts the whole company, not just you,
the founder. Which is why you mostly see these deals peddled by VCs without a
track record.

Even if you can't get a different deal you might want to pass. There's just no
point. Unless all you want is a salary.

------
blazespin
I think something needs to be said about context. Some ventures will be more
successful by raising more / diluting more, while others the cash will just
hurt. Some examples: hardware plays versus an AI startup.

------
Kiro
> raise $5 million on a $10 million pre-money valuation (selling 33% of the
> company to investors)

How do these calculations work?

~~~
tyre
The pre-money valuation is what you are worth before the investment. So you're
saying "we have a company worth $10 million" and the investor is saying "cool,
let me give you $5 million."

So now you have $10 million in company plus $5 million in cash, so you are
worth $15 million (that's called the post-money valuation.) The investor gets
$5m / $15m—33% of the company.

------
neom
Money is simply wind in the sails.

~~~
neom
The fact that I got voted down on this just goes to show the level of ability
to understand reality HN has. HN is a bubble.

~~~
marktangotango
I didn't down vote, but your comment was banal and didn't add anything to the
discussion. HN aspires to a higher level of discourse, as you probably know.
Just glanced at your profile, you probably have a lot of insight that everyone
would find interesting!

------
pdog
_> Most founders' instincts seem to be to give too much equity to investors
and not enough to employees._

Is this wrong? Investors don't receive anything for their capital but equity.
Employees receive income, benefits, etc. that have to be factored into the
equation.

~~~
tyre
It's absolutely wrong! Employees are the ones who put in the work to actually
build the company.

As you said, investors only put in capital (and sometimes advice and/or
intros.) Employees work full-time on the company, oftentimes for below-market
rates (what they could reasonably assume to make in salary + benefits at
larger companies.)

A company at any size is far, far, far more likely to succeed or fail based on
its employees than its investors.

~~~
maxxxxx
Employees also take more risk. Investors just lose money but employees lose
years of their career if things go wrong.

~~~
kinkrtyavimoodh
Why would employees lose years of their career? While it's true that early
work-ex in a company that eventually becomes Google is great to have, it's not
exactly a black mark on your resume if you have worked in a company that
didn't do well. You still got plenty of engineering experience.

~~~
100k
Sadly, four years of "heroic effort at failing startup" doesn't look as good
on the resume as "worked at Google".

~~~
maxxxxx
A lot of startups aren't even technically very advanced so the only thing you
may have learned is to work 80 hours per week without complaining

