Visualizing Dilution

VISUALIZING DILUTION 1 pixel = $250 = $1M Most founders don't give much thought to their ownership percentage and the dilution of their shares over time. This graphic may encourage you to give your future a bit more thought before getting started. The founding team raises money from angels. In a booming market (like 2011) sometimes this isn't priced. The industry normis around 20% $500k $2.5M post-money valuation 20% 80% When the first "institutional" investors put in their A-round money they will require you to have a stock option plan to incentivize senior management to work with you. The angels & founders absorb this dilution. $3M $12M post-money valuation 25% 12.5% 50% It is not uncommon for your next-round investors (the B round) to ask for a "top up" of the employee stock options so you can continue to recruit A-players to join your company. $8M $32M post-money valuation 6% 25% 35% Series C investors come in and the ESOP is topped up again. $12M $48M post-money valuation 3% $25% 25% If you continue to perform well at each funding round (as this graphic depicts), then the dilution you have experienced as founders is more than offset by increases in valuation and, therefore, you have more total value in your stock. The majority of companies miss milestones, which is where the penalizing dilution comes in. Founders are diluted to 25% from 100% Angels are diluted to 6% from 20% A investors arediluted to 12% from 25% Binvestors are diluted to 18% from 25% C investors are not diluted as last ones in Let's say all goes well and the company is sold for $48M at year 5. The founders exit with $12M. Which is then split between the four founders at $3M each. Which over 5 years averages to $600k per year in pre-tax income. Which is good, but not exactly FU money. If you held stock, you would be taxed at the long-term capital gains rate, which in 2011 is just 15% federal and additional state taxes. If you hold stock options- uh oh - you're likely taxed at the "income tax" rate, which in California could set your total tax rate at 42.5%. So $3M becomes $1.725M, or $345k per year. And that is with favorable terms. What if the Angels took 30% instead of 20% and the VC's took 40% per round instead of 25%? With the same total investment ($23.5M), the company would look much different. 40% 22% 11% 15% 4% 9% $30M post-money valuation In fact, if you take the above founder slice and turn it on its side, the total value of the founder shares many years later is only $700k more than it was in the first example's seed round. This isn't uncommon. After the four founders take their share. You end up with $135K per year. With participating liquidation preferences you can 'exit' with an average of $20k per year.. .on a $30M sale. Dilution adds up. We've shown the better outcomes for founders. The total number of co-founders you start with can be the biggest factor in how much you exit with in a middle-outcome case. The terms you negotiate with VCs can impact greatly how much you ultimately get paid. Pay special attention to "participating preferred equity" and, if possible, avoid it. And note that management who stay from start to exit often make the most money because they get "topped up" along the way. Founders who leave are often diluted the most over time. BothSidesofTheTable.com (visual ly