10 ms·

>"yay, X% means I get X% of the company!" and then I found out the shares can be diluted. There seems to be a common misunderstanding about dilution. Dilutio

by jasode 9y ago

>"yay, X% means I get X% of the company!" and then I found out the shares can be diluted. There seems to be a common misunderstanding about dilution. Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership. How do current owners who collectively own 100% of the shares "sell" more shares to future owners?!? By way of dilution. That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too. More important than dilution is the shares multiplied by price.

nissimk 9y ago
If dilution is a non issue then why do professional venture investors demand anti dilution clauses?
- harryh 9y ago
  Professional investors generally get pro rata rights which allows them to buy more stock in later rounds. They do this because they want the ability to buy more shares in companies that are succeeding. They don't get magic stock that magically doesn't get diluted.
  - sroussey 9y ago
    Ratchets are a thing, far less common in the valley in the last decade than the decade before, particularly at earlier stages. Founders can put them in as well. Don't forget warrants as part of a deal too.
  - PeterFBell 9y ago
    They used to! Ask anyone who was involved in startups around 200-2002 about the full-ratchet anti-dilution provisions many investors demanded and received. Not fun for anyone else in a down round . . .
    - jhall1468 9y ago
      Down-rounds were huge back then, regardless weighted average was still the more common way of doing things, even in the early 2000s. Often times, these days, startups are putting pay to play provisions in, so even the weighted average ratchet requires them to keep investing in order to receive their anti-dilution. Honestly, unless a startup has SERIOUS capital problems, an anti-dilution isn't going to make it's way into a share purchase, so the companies that are still seeing this (and the ones from the early 2000s) weren't in incredible shape to begin with.
  - Pyxl101 9y ago
    Why shouldn't employees also demand, and also be given, the right to buy more shares in subsequent funding rounds? If I was going to work at a company for X% ownership, I'd sure expect to have the right to invest my own money to preserve my stake in a funding round and avoid dilution. Many employees might not exercise this privilege, since it would require putting (potentially a lot of) cash back into the company, but why aren't they given the choice? I also might expect to receive the same liquidation preference on any shares purchased in cash this way. I'm not sure I could be comfortable working for a startup without pro rata rights and relatively full knowledge of the cap table and preferences. That's probably why I'm not working at a startup.
    - harryh 9y ago
      1) It would generally be a poor investment choice for an employee to invest their savings in a startup that they were actively working for. Startup employees are already over-invested in their company from a diversification perspective. 2) The majority of startup employees are unlikely to have the cash on hand to make that kind of investment. Because of #1 and #2 this isn't something that most employees would care about so it's not part of any standard compensation package. It's possible that an employee could negotiate for such a provision though. The fact that you would want a pro rata right to work at a startup does make you fairly unusual and I agree goes to explain why you have chosen other career options.
icedchai 9y ago
Price alone will not tell you everything. Let's not forget about different classes of stock: preferred vs common. There are often other rights associated with preferred / investor shares: liquidation preferences, warrants, etc. Rarely can the average employee get these details.
cynicalbastard 9y ago
> That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too. founders, angels, and early round VCs can simply issue themselves more stock from the pool of unissued shares to counteract dilution.
- rmah 9y ago
  No they can't. I don't doubt that this has happened before and I'm sure someone can dig up an example or two. However, what you describe is highly questionable and borderline illegal. It's certainly grounds for a lawsuit by other shareholders (including options holders).
  - ep103 9y ago
    Eh, this is exactly what happened to a friend of mine. The rationale later, was he had been promised X percent, but when the final deal went through, they diluted different pools of company stock to different percentages, and his values went down to 1/10 what he was expecting. I know I'm missing a lot of info, and its just a second hand example, but it seems in line with grand parent post's idea that for each type of financial tool, there's at least one gotcha you need to be aware of.
  - theptip 9y ago
    Yes, they can. The board has discretion over the allocation of the options pool that will have been set aside as part of each round. However to issue those to yourself would be like eating your seed stock, since that's the pool that you use for issuing options to new hires, and without that you can't give new employees any equity. For that reason I don't think it's likely.
    - state_less 9y ago
      I think what the grandparent comment is getting at is that you as an employee have little control over the delayed compensation strategy. If you're lucky, you have a honest founder and investors who make sure you're paid for your contribution at deal closing time. If you're not lucky, you have a board/CEO/founder that will take whatever they can get away with (e.g. your value add) and then point to the financial rules/contingencies and say, "Well, we tried to do all we could, but we had to do this to ensure the success of the company. We needed to compensate the administration because it's hard to find such good talent like ourselves. Your still getting something here..." Or some such line. And you end up with some minuscule share at the same time providing critical value to the business.
oillio 9y ago
I hear this argument a lot. Mostly from people trying to sell the idea of a highly dilutive funding round. Sure, further rounds are a sign the company is doing well. The important word being "sign," they don't actually make the company more valuable (what the company does with the money they raise does). If you own a lot of stock, you probably already know if the company is doing well or not. In that respect, the round just puts a number on what you already know. The math is simple. All things being equal, owning more % of a company == more money. To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.
- icedchai 9y ago
  Except, all things usually aren't equal. Most people explain dilution like this: you're getting a smaller piece of a bigger pie.
  - mikepurvis 9y ago
    At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie. But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.
    - nathanstitt 9y ago
      Exactly! Thanks for pointing this out because everyone seems to miss it. At the moment that an investment is made, a company should be worth just as much as it was before, but will have more liquid assets because it's traded equity for cash. The question for employees and shareholders then becomes: "Do you believe management is capable of using the cash to build additional value, or will they waste it?"
    - wruza 9y ago
      If you're getting exactly the same size of piece, why name it "per cent"?
_jal 9y ago
> In fact, dilution is a positive sign Sometimes. But if this were simply a case of ignorance-correction, certain preferred investors would never ask for pro-rata, or everyone would be offered pro-rata.
graphitezepp 9y ago
This seems like it supports the idea of how the knowledge needed to understand options adds up to become impracticaly large for non finance people.
s73ver 9y ago
Dilution is only a positive sign if your stake is increased to compensate. Otherwise it means you're working for less than you agreed to.
gumby 9y ago
> Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership. This doesn't just apply to company shares (a topic which causes people to not think rationally, for some reason). It applies to a market. Sun's CEO MacNeilly famously said that he liked open systems (in the case of BSD Unix) because "it increases the pie. Our slice gets smaller but all these participants grow the overall pie faster, so our revenues go up." What fascinated me at the time was how the business press was puzzled by his statement -- they had a more zero sum view of markets in the late 80s/early 90s. Nowadays people understand that the existence of Lyft helps Uber, and vice versa. And the same is true with people who want to buy your shares.
kbutler 9y ago
> More important than dilution is the shares multiplied by price. But even with an "up round", where ownership percentage is diluted but your n-shares * price goes up, liquidation preferences can reduce or eliminate your value.* As the GP said, there's always that "one more thing" that can wipe out your value. (*citation: personal experience)

by jasode 9y ago

nissimk 9y ago

If dilution is a non issue then why do professional venture investors demand anti dilution clauses?

harryh 9y ago
Professional investors generally get pro rata rights which allows them to buy more stock in later rounds. They do this because they want the ability to buy more shares in companies that are succeeding. They don't get magic stock that magically doesn't get diluted.
- sroussey 9y ago
  Ratchets are a thing, far less common in the valley in the last decade than the decade before, particularly at earlier stages. Founders can put them in as well. Don't forget warrants as part of a deal too.
- PeterFBell 9y ago
  They used to! Ask anyone who was involved in startups around 200-2002 about the full-ratchet anti-dilution provisions many investors demanded and received. Not fun for anyone else in a down round . . .
  - jhall1468 9y ago
    Down-rounds were huge back then, regardless weighted average was still the more common way of doing things, even in the early 2000s. Often times, these days, startups are putting pay to play provisions in, so even the weighted average ratchet requires them to keep investing in order to receive their anti-dilution. Honestly, unless a startup has SERIOUS capital problems, an anti-dilution isn't going to make it's way into a share purchase, so the companies that are still seeing this (and the ones from the early 2000s) weren't in incredible shape to begin with.
- Pyxl101 9y ago
  Why shouldn't employees also demand, and also be given, the right to buy more shares in subsequent funding rounds? If I was going to work at a company for X% ownership, I'd sure expect to have the right to invest my own money to preserve my stake in a funding round and avoid dilution. Many employees might not exercise this privilege, since it would require putting (potentially a lot of) cash back into the company, but why aren't they given the choice? I also might expect to receive the same liquidation preference on any shares purchased in cash this way. I'm not sure I could be comfortable working for a startup without pro rata rights and relatively full knowledge of the cap table and preferences. That's probably why I'm not working at a startup.
  - harryh 9y ago
    1) It would generally be a poor investment choice for an employee to invest their savings in a startup that they were actively working for. Startup employees are already over-invested in their company from a diversification perspective. 2) The majority of startup employees are unlikely to have the cash on hand to make that kind of investment. Because of #1 and #2 this isn't something that most employees would care about so it's not part of any standard compensation package. It's possible that an employee could negotiate for such a provision though. The fact that you would want a pro rata right to work at a startup does make you fairly unusual and I agree goes to explain why you have chosen other career options.

icedchai 9y ago

Price alone will not tell you everything. Let's not forget about different classes of stock: preferred vs common. There are often other rights associated with preferred / investor shares: liquidation preferences, warrants, etc. Rarely can the average employee get these details.

cynicalbastard 9y ago

> That means everybody gets diluted including the founders, the angels, the VCs, and yes the employees too. founders, angels, and early round VCs can simply issue themselves more stock from the pool of unissued shares to counteract dilution.

rmah 9y ago
No they can't. I don't doubt that this has happened before and I'm sure someone can dig up an example or two. However, what you describe is highly questionable and borderline illegal. It's certainly grounds for a lawsuit by other shareholders (including options holders).
- ep103 9y ago
  Eh, this is exactly what happened to a friend of mine. The rationale later, was he had been promised X percent, but when the final deal went through, they diluted different pools of company stock to different percentages, and his values went down to 1/10 what he was expecting. I know I'm missing a lot of info, and its just a second hand example, but it seems in line with grand parent post's idea that for each type of financial tool, there's at least one gotcha you need to be aware of.
- theptip 9y ago
  Yes, they can. The board has discretion over the allocation of the options pool that will have been set aside as part of each round. However to issue those to yourself would be like eating your seed stock, since that's the pool that you use for issuing options to new hires, and without that you can't give new employees any equity. For that reason I don't think it's likely.
  - state_less 9y ago
    I think what the grandparent comment is getting at is that you as an employee have little control over the delayed compensation strategy. If you're lucky, you have a honest founder and investors who make sure you're paid for your contribution at deal closing time. If you're not lucky, you have a board/CEO/founder that will take whatever they can get away with (e.g. your value add) and then point to the financial rules/contingencies and say, "Well, we tried to do all we could, but we had to do this to ensure the success of the company. We needed to compensate the administration because it's hard to find such good talent like ourselves. Your still getting something here..." Or some such line. And you end up with some minuscule share at the same time providing critical value to the business.

oillio 9y ago

I hear this argument a lot. Mostly from people trying to sell the idea of a highly dilutive funding round. Sure, further rounds are a sign the company is doing well. The important word being "sign," they don't actually make the company more valuable (what the company does with the money they raise does). If you own a lot of stock, you probably already know if the company is doing well or not. In that respect, the round just puts a number on what you already know. The math is simple. All things being equal, owning more % of a company == more money. To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.

icedchai 9y ago
Except, all things usually aren't equal. Most people explain dilution like this: you're getting a smaller piece of a bigger pie.
- mikepurvis 9y ago
  At the moment that the dilution occurs, you're getting exactly the same size of piece, it's just a smaller proportion of a bigger pie. But I suppose the idea is that a bigger pie is able to expand larger and faster than it would have been otherwise.
  - nathanstitt 9y ago
    Exactly! Thanks for pointing this out because everyone seems to miss it. At the moment that an investment is made, a company should be worth just as much as it was before, but will have more liquid assets because it's traded equity for cash. The question for employees and shareholders then becomes: "Do you believe management is capable of using the cash to build additional value, or will they waste it?"
  - wruza 9y ago
    If you're getting exactly the same size of piece, why name it "per cent"?

_jal 9y ago

> In fact, dilution is a positive sign Sometimes. But if this were simply a case of ignorance-correction, certain preferred investors would never ask for pro-rata, or everyone would be offered pro-rata.

graphitezepp 9y ago

This seems like it supports the idea of how the knowledge needed to understand options adds up to become impracticaly large for non finance people.

s73ver 9y ago

Dilution is only a positive sign if your stake is increased to compensate. Otherwise it means you're working for less than you agreed to.

gumby 9y ago

> Dilution is not really the issue. In fact, dilution is a positive sign. It means more investors value the company and want to buy into the ownership. This doesn't just apply to company shares (a topic which causes people to not think rationally, for some reason). It applies to a market. Sun's CEO MacNeilly famously said that he liked open systems (in the case of BSD Unix) because "it increases the pie. Our slice gets smaller but all these participants grow the overall pie faster, so our revenues go up." What fascinated me at the time was how the business press was puzzled by his statement -- they had a more zero sum view of markets in the late 80s/early 90s. Nowadays people understand that the existence of Lyft helps Uber, and vice versa. And the same is true with people who want to buy your shares.

kbutler 9y ago

> More important than dilution is the shares multiplied by price. But even with an "up round", where ownership percentage is diluted but your n-shares * price goes up, liquidation preferences can reduce or eliminate your value.* As the GP said, there's always that "one more thing" that can wipe out your value. (*citation: personal experience)