12 ms·

Dilution

486 points by firloop 10y ago

pdog 10y ago
> 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.
- anandkulkarni 10y ago
  In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor. Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the company, versus your first engineer, which would be more damaging? The investor's money is already in the bank, whereas the engineer will cost time and money to replace, as well as disrupting the ongoing development.
  - jimmykennedy 10y ago
    "It's more valuable to have them invested long-term in the company's success." Why? A cash bonus of "If we meet this deadline you will receive $X" is going to increase my productivity much more than "you own 0.01% of an illiquid, unprofitable company". Startup equity is way too abstract for employees to affect their motivation. Peer pressure, mission, pride in work, cash bonuses / raises / promotions are infinitely more impactful.
    - firloop 10y ago
      Sure, the argument isn't that equity is the end-all to employee compensation. But early-stage startups often aren't able to to give (significant) cash bonuses, and more importantly, compensating an employee with equity means that 5 years down the line, you're more likely to have someone on the cap table that both contributed to past efforts that made the company successful and also cares about the company's future. I think in practice this preference makes more sense when you consider that most of the (non capital based) value that early-stage investors can provide applies mostly to early-stage companies.
    - Retric 10y ago
      It's not about having equity now. If you have a seed company that fails in two years then the equity equation is meaningless. However, if in two years things are going good, but it's not clear you are the next google then you really don't want to lose key employees and it's going to take more equity to keep them interested. On the other hand if in two years it looks like you will be the next google then getting more capital is easy and you really don't want to lose a key person.
  - rqebmm 10y ago
    I'd argue the better analogy is "If you have a great idea, what's more important to get it to market: your first engineer or your first investor?" The next is always going to be "well, do I have enough money to pay my engineer?" This is why the investor holds all the cards and therefore gets the best deal up front. Without that up-front money there is no eventual business.
    - jacquesm 10y ago
      That's not true. You have the option to give that engineer a real slice of the cake instead of the misers share that's common. I've seen co-founders be labeled 'engineer #1' because they sat down 15 minutes after the first meeting where a company's founding was discussed. Non technical founders can - and do - use investors money to try to limit the number of co-founders so they get a larger share themselves. Technical founders are less likely to do this to non-technical co-founders. (But it does happen.)
      - softawre 10y ago
        > Technical founders are less likely to do this to non-technical co-founders. (But it does happen.) Technical people are so great, aren't they! No bias here.
        jacquesm 10y ago
        It's not that they're 'so great' it's just that they are usually less business savvy and doing less 'jockeying for position'. They tend to not be in it for the money as much as they're in for the challenge which makes it relatively easy to take advantage of them. (Been there, done that, have several t-shirts to go with it and I promise it won't happen again but if I had known 20 years ago what I know now... never mind, hindsight is always perfect.)
- tyre 10y ago
  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.
  - idiot_stick 10y ago
    >Employees are the ones who put in the work to actually build the company. Company and work that, in most cases, wouldn't exist without a capital investment.
    - mianos 10y ago
      It may be the chicken or the egg, but, if you have some employee that can achieve something that others can't, he can go somewhere else and achieve the same. The money could be equally applied and it will not bring success. No money means failure but no employee means no chance of success, money or not.
    - nostrademons 10y ago
      I'd question that, actually. The vast majority of huge tech companies that you've heard of today - Microsoft, Apple, Google, Facebook, Amazon, EBay, AirBnB, Whatsapp, Snapchat, GitHub - managed to construct a working product without taking investment. Several others - DropBox, Stripe, Instagram, Slack - had only a relatively small seed or angel round before launching a product. Meanwhile the track record for companies that take a huge amount of investment before delivering a product - Theranos, Webvan, Go, Magic Leap, etc. - is pretty abysmal. YC and several other top-tier VCs recommend that you keep the startup as small as possible, oftentimes just the founding team, until you've built a product that's popular enough that you're swamped with demand. Then you can go and raise working capital to fund expansion and fuel growth, but not before. It's not true that the company wouldn't exist without the capital investment, though - it's actually pretty critical that the company does exist before raising capital.
    - 10y ago
- nostrademons 10y ago
  I think this is saying that founders often underestimate the variance that employees bring to their company's success, and overestimate the variance that an investment round brings. If you assume that employees are basically fungible and that $100K in salary will buy the same output regardless of who works for you and how motivated they are, then it makes sense to raise $10M rather than $2M, so you can hire 100 person-years of work rather than 20 person-years. VCs become the limiting factor. If you assume that there are wide varieties in employee output that stem from a.) hiring the right employees b.) into the right roles and c.) compensating them so that they're incentivized to do their best, then it becomes absolutely critical to attract those employees and motivate them. It is unlikely that you will attract these types of employees for a $100K/year salary. It is far more likely that you will attract them with a percent or two of equity that could be worth several million dollars. In my experience, the latter is a much closer description of reality than the former is. From the entrepreneur's perspective, what investors or employees "deserve" is irrelevant, what matters is how much of an effect they have on the ability to deliver a good product to a big market. Early employees are in the trenches with you every day; the difference between high effort and low effort from them can make or break the company. Investors give you money and often advice/introductions, but you are one of many investments in their portfolio; they are not going to give you high effort.
- bbcbasic 10y ago
  My understanding is that employees will be paid less than what they could earn elsewhere, so need to be compensated with some upside for that shortfall. If I were to cut your pay by $100k to join my company, would you say, ah OK but I am still receiving income & benefits, don't worry about it? If you have to leave your 9-5 to work for my 10-"late" for the same salary, would you want something extra for that, even if it is just a high-EV lotto ticket? Another argument, made in the article is that if you want to attract the best talent you need to make an attractive offer. Otherwise why wouldn't the people you want just go work for Google or another startup, or start their own?
- CalChris 10y ago
  Employees take a risk. First, they don't have to work for your startup. They could go to work for BigCo and have a secure paycheck. Second, they get options for common stock which vest over years. Generally that first year is at will.
birken 10y ago
> 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.
- k__ 10y ago
  Yes, I don't understand the whole investor hype. I mean, I do contract work with startups and get paid with investor money all the time, so it's good for me. But I think most investors are a liability. First you have to make your employees and your customers happy and now you also have to make investors happy? How shoult this be a good thing? It's hard enough to build products for users I can't directly interact with, why should this equation get another variable :\
  - marcofloriano 10y ago
    Maybe one thing lead to another. By making your customers and employees happy, you make your investors happy. The money makes sense when you need to scale fast. Specially in the development stage, when you don't make a dime yet. With the advance of the internet marketing, it's don't make much sense, as you put. Investors should be moving their money from internet, i think, to AI, Space, Augmented reality and so on. They should fund stuff that is really risky. Turns up ... internet is not risky anymore.
    - WalterSear 10y ago
alexmingoia 10y ago
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.
65827 10y ago
I think the spectacular real time failure of Uber is going to drive a lot of those valuations down.
- CalChris 10y ago
  I think you're right but VCs have only themselves to blame for that fiasco.
achou 10y ago
"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.
blazespin 10y ago
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.
matchagaucho 10y ago
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 10y ago
  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 10y ago
    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.
  - tyre 10y ago
    There is a 100% chance that they did not get money/term sheets from 100% of VCs that they pitched. Don't feel bad, raising money is really fucking hard, stressful, random, and involves a lot of luck.
lpolovets 10y ago
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.
- lancewiggs 10y ago
  We are VC/early stage investors in New Zealand, and give the advice constantly to raise as little as possible at each stage - and plan to get back to cash-flow positive if another round does not turn up. It's a function of our lean investor ecosystem here, but it also creates companies that treasure every dollar and are even more attractive for investors.
  - lpolovets 10y ago
    I think that's a great mindset to have and to encourage. My main argument is that "as little as possible" -- especially in Silicon Valley -- is usually much closer to 20% than 10% dilution at seed. E.g. an FTE salary might be $125k-150k/yr, and selling 10% at a $5m cap gives you enough capital for 3-4 people for a year, which is a very small team and very little time to make enough progress to raise a Series A.
    - lancewiggs 10y ago
      Sure. Our overheads are a lot lower here - free healthcare, Xero for accounting and a simple tax system makes things easy, low rent, reasonable salaries (but a better standard of living) and so on. And no capital gains tax.
neom 10y ago
Money is simply wind in the sails.
- neom 10y ago
  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 10y ago
    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!
jmspring 10y ago
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 10y ago
  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 10y ago
    >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.
oculusthrift 10y ago
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.
- nostrademons 10y ago
  Historically, when this has happened, it's because the founders have managed to build the product & get on the growth trajectory before taking investment. Bill Gates built Altair Basic, sold it to hobbyists, and reinvested the profits to buy MS-DOS and sell it to IBM. Larry & Sergey had a working search engine that was using up half of Stanford's bandwidth before they took their first angel investment. Facebook was a dorm-room project. SnapChat was a final project for a Stanford product-design course and had 100k users before it took investment. The Apple 1 was done in Steve Wozniak's nights & weekends, and had sold out before they took investment for the Apple 2. If you have a working product and ideally money coming in, the early negotiation leverage changes dramatically. You can skip the seed round entirely, because you've already seeded the project. You can usually get a very good valuation on Series A, since your metrics look great and every VC wants a piece of you. You can negotiate to give away very low equity stakes in later rounds, since at that point you seem like a sure thing. The flip side is that most side projects don't go anywhere. You need to be both very dedicated and very lucky to strike it big without investment.
- jacquesm 10y ago
  > 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 10y ago
    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.
amorphid 10y ago
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 10y ago
  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 10y ago
    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 10y ago
      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.
sama 10y ago
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 10y ago
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.
jartelt 10y ago
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.
Abundnce10 10y ago
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 10y ago
  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.
Kiro 10y ago
> raise $5 million on a $10 million pre-money valuation (selling 33% of the company to investors) How do these calculations work?
- tyre 10y ago
  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.
- sja 10y ago
  Worth of company before investor gives company cash (pre-money valuation): $10 million Worth of company after adding $5 million from investor: $15 million. Investor now owns $5 million dollars "worth" of a now $15 million company $5 / $15 = ~33%
- deleted 10y ago
  [deleted]
antidilution 10y ago
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 10y ago
  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.
Quanticles 10y ago
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 10y ago
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.
auganov 10y ago
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.
equalarrow 10y ago
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.
lmeyerov 10y ago
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").
dandare 10y ago
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?

486 points by firloop 10y ago

pdog 10y ago

> 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.

anandkulkarni 10y ago
In the final calculation, employees are the ones who are toiling day-in and day-out for the company's well being – in a real way, the company's future depends on them more than the investors. It can be more valuable to have them invested long-term in the company's success, point for point, than an investor. Another way to think about it is like this: if an investor told you tomorrow they'd no longer contribute to the company, versus your first engineer, which would be more damaging? The investor's money is already in the bank, whereas the engineer will cost time and money to replace, as well as disrupting the ongoing development.
- jimmykennedy 10y ago
  "It's more valuable to have them invested long-term in the company's success." Why? A cash bonus of "If we meet this deadline you will receive $X" is going to increase my productivity much more than "you own 0.01% of an illiquid, unprofitable company". Startup equity is way too abstract for employees to affect their motivation. Peer pressure, mission, pride in work, cash bonuses / raises / promotions are infinitely more impactful.
  - firloop 10y ago
    Sure, the argument isn't that equity is the end-all to employee compensation. But early-stage startups often aren't able to to give (significant) cash bonuses, and more importantly, compensating an employee with equity means that 5 years down the line, you're more likely to have someone on the cap table that both contributed to past efforts that made the company successful and also cares about the company's future. I think in practice this preference makes more sense when you consider that most of the (non capital based) value that early-stage investors can provide applies mostly to early-stage companies.
  - Retric 10y ago
    It's not about having equity now. If you have a seed company that fails in two years then the equity equation is meaningless. However, if in two years things are going good, but it's not clear you are the next google then you really don't want to lose key employees and it's going to take more equity to keep them interested. On the other hand if in two years it looks like you will be the next google then getting more capital is easy and you really don't want to lose a key person.
- rqebmm 10y ago
  I'd argue the better analogy is "If you have a great idea, what's more important to get it to market: your first engineer or your first investor?" The next is always going to be "well, do I have enough money to pay my engineer?" This is why the investor holds all the cards and therefore gets the best deal up front. Without that up-front money there is no eventual business.
  - jacquesm 10y ago
    That's not true. You have the option to give that engineer a real slice of the cake instead of the misers share that's common. I've seen co-founders be labeled 'engineer #1' because they sat down 15 minutes after the first meeting where a company's founding was discussed. Non technical founders can - and do - use investors money to try to limit the number of co-founders so they get a larger share themselves. Technical founders are less likely to do this to non-technical co-founders. (But it does happen.)
    - softawre 10y ago
      > Technical founders are less likely to do this to non-technical co-founders. (But it does happen.) Technical people are so great, aren't they! No bias here.
      - jacquesm 10y ago
        It's not that they're 'so great' it's just that they are usually less business savvy and doing less 'jockeying for position'. They tend to not be in it for the money as much as they're in for the challenge which makes it relatively easy to take advantage of them. (Been there, done that, have several t-shirts to go with it and I promise it won't happen again but if I had known 20 years ago what I know now... never mind, hindsight is always perfect.)
tyre 10y ago
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.
- idiot_stick 10y ago
  >Employees are the ones who put in the work to actually build the company. Company and work that, in most cases, wouldn't exist without a capital investment.
  - mianos 10y ago
    It may be the chicken or the egg, but, if you have some employee that can achieve something that others can't, he can go somewhere else and achieve the same. The money could be equally applied and it will not bring success. No money means failure but no employee means no chance of success, money or not.
  - nostrademons 10y ago
    I'd question that, actually. The vast majority of huge tech companies that you've heard of today - Microsoft, Apple, Google, Facebook, Amazon, EBay, AirBnB, Whatsapp, Snapchat, GitHub - managed to construct a working product without taking investment. Several others - DropBox, Stripe, Instagram, Slack - had only a relatively small seed or angel round before launching a product. Meanwhile the track record for companies that take a huge amount of investment before delivering a product - Theranos, Webvan, Go, Magic Leap, etc. - is pretty abysmal. YC and several other top-tier VCs recommend that you keep the startup as small as possible, oftentimes just the founding team, until you've built a product that's popular enough that you're swamped with demand. Then you can go and raise working capital to fund expansion and fuel growth, but not before. It's not true that the company wouldn't exist without the capital investment, though - it's actually pretty critical that the company does exist before raising capital.
  - 10y ago
nostrademons 10y ago
I think this is saying that founders often underestimate the variance that employees bring to their company's success, and overestimate the variance that an investment round brings. If you assume that employees are basically fungible and that $100K in salary will buy the same output regardless of who works for you and how motivated they are, then it makes sense to raise $10M rather than $2M, so you can hire 100 person-years of work rather than 20 person-years. VCs become the limiting factor. If you assume that there are wide varieties in employee output that stem from a.) hiring the right employees b.) into the right roles and c.) compensating them so that they're incentivized to do their best, then it becomes absolutely critical to attract those employees and motivate them. It is unlikely that you will attract these types of employees for a $100K/year salary. It is far more likely that you will attract them with a percent or two of equity that could be worth several million dollars. In my experience, the latter is a much closer description of reality than the former is. From the entrepreneur's perspective, what investors or employees "deserve" is irrelevant, what matters is how much of an effect they have on the ability to deliver a good product to a big market. Early employees are in the trenches with you every day; the difference between high effort and low effort from them can make or break the company. Investors give you money and often advice/introductions, but you are one of many investments in their portfolio; they are not going to give you high effort.
bbcbasic 10y ago
My understanding is that employees will be paid less than what they could earn elsewhere, so need to be compensated with some upside for that shortfall. If I were to cut your pay by $100k to join my company, would you say, ah OK but I am still receiving income & benefits, don't worry about it? If you have to leave your 9-5 to work for my 10-"late" for the same salary, would you want something extra for that, even if it is just a high-EV lotto ticket? Another argument, made in the article is that if you want to attract the best talent you need to make an attractive offer. Otherwise why wouldn't the people you want just go work for Google or another startup, or start their own?
CalChris 10y ago
Employees take a risk. First, they don't have to work for your startup. They could go to work for BigCo and have a secure paycheck. Second, they get options for common stock which vest over years. Generally that first year is at will.

birken 10y ago

> 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.

k__ 10y ago
Yes, I don't understand the whole investor hype. I mean, I do contract work with startups and get paid with investor money all the time, so it's good for me. But I think most investors are a liability. First you have to make your employees and your customers happy and now you also have to make investors happy? How shoult this be a good thing? It's hard enough to build products for users I can't directly interact with, why should this equation get another variable :\
- marcofloriano 10y ago
  Maybe one thing lead to another. By making your customers and employees happy, you make your investors happy. The money makes sense when you need to scale fast. Specially in the development stage, when you don't make a dime yet. With the advance of the internet marketing, it's don't make much sense, as you put. Investors should be moving their money from internet, i think, to AI, Space, Augmented reality and so on. They should fund stuff that is really risky. Turns up ... internet is not risky anymore.
  - WalterSear 10y ago

alexmingoia 10y ago

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.

65827 10y ago

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

CalChris 10y ago
I think you're right but VCs have only themselves to blame for that fiasco.

achou 10y ago

"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.

blazespin 10y ago

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.

matchagaucho 10y ago

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 10y ago
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 10y ago
  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.
- tyre 10y ago
  There is a 100% chance that they did not get money/term sheets from 100% of VCs that they pitched. Don't feel bad, raising money is really fucking hard, stressful, random, and involves a lot of luck.

lpolovets 10y ago

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.

lancewiggs 10y ago
We are VC/early stage investors in New Zealand, and give the advice constantly to raise as little as possible at each stage - and plan to get back to cash-flow positive if another round does not turn up. It's a function of our lean investor ecosystem here, but it also creates companies that treasure every dollar and are even more attractive for investors.
- lpolovets 10y ago
  I think that's a great mindset to have and to encourage. My main argument is that "as little as possible" -- especially in Silicon Valley -- is usually much closer to 20% than 10% dilution at seed. E.g. an FTE salary might be $125k-150k/yr, and selling 10% at a $5m cap gives you enough capital for 3-4 people for a year, which is a very small team and very little time to make enough progress to raise a Series A.
  - lancewiggs 10y ago
    Sure. Our overheads are a lot lower here - free healthcare, Xero for accounting and a simple tax system makes things easy, low rent, reasonable salaries (but a better standard of living) and so on. And no capital gains tax.

neom 10y ago

Money is simply wind in the sails.

neom 10y ago
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 10y ago
  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!

jmspring 10y ago

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 10y ago
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 10y ago
  >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.

oculusthrift 10y ago

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.

nostrademons 10y ago
Historically, when this has happened, it's because the founders have managed to build the product & get on the growth trajectory before taking investment. Bill Gates built Altair Basic, sold it to hobbyists, and reinvested the profits to buy MS-DOS and sell it to IBM. Larry & Sergey had a working search engine that was using up half of Stanford's bandwidth before they took their first angel investment. Facebook was a dorm-room project. SnapChat was a final project for a Stanford product-design course and had 100k users before it took investment. The Apple 1 was done in Steve Wozniak's nights & weekends, and had sold out before they took investment for the Apple 2. If you have a working product and ideally money coming in, the early negotiation leverage changes dramatically. You can skip the seed round entirely, because you've already seeded the project. You can usually get a very good valuation on Series A, since your metrics look great and every VC wants a piece of you. You can negotiate to give away very low equity stakes in later rounds, since at that point you seem like a sure thing. The flip side is that most side projects don't go anywhere. You need to be both very dedicated and very lucky to strike it big without investment.
jacquesm 10y ago
> 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 10y ago
  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.

amorphid 10y ago

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 10y ago
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 10y ago
  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 10y ago
    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.

sama 10y ago

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 10y ago

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.

jartelt 10y ago

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.

Abundnce10 10y ago

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 10y ago
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.

Kiro 10y ago

> raise $5 million on a $10 million pre-money valuation (selling 33% of the company to investors) How do these calculations work?

tyre 10y ago
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.
sja 10y ago
Worth of company before investor gives company cash (pre-money valuation): $10 million Worth of company after adding $5 million from investor: $15 million. Investor now owns $5 million dollars "worth" of a now $15 million company $5 / $15 = ~33%
deleted 10y ago
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antidilution 10y ago

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 10y ago
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.

Quanticles 10y ago

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 10y ago

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.

auganov 10y ago

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.

equalarrow 10y ago

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.

lmeyerov 10y ago

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").

dandare 10y ago

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?