4 ms·

Equity Investment Simulation: Illustrating Dilution

79 points by snampall 15y ago

patio11 15y ago
Note in particular how option pools dilute founders, not investors. My understanding is that is actually negotiable, but it is an easy way for unsavvy founders to have the valuation they negotiate not mean what they think it means. (Ditto not understanding what Pre- and post-money valuations mean.) Example: suppose I, a clueless tech guy, am negotiating with a savvy and aggressive money-guy. Assume for sake of argument we're raising $1 million, and my naive thoughts are that "The company is worth $5 million." Me: "The company is worth $5 million." Him: "We can totally work with a $5 million post-money valuation." Me: "Great." Almost everyone on HN knows I screwed myself. You think I just priced the company down to $4 million, right? Yeah, even worse. Him: "So you know, it is customary for companies in Silicon Valley to make generous equity grants to attract and retain employees." Me: "Oh totally." Him: "The standard is 20%. You could get a lower number, but honestly, you'd look like a greedy bastard out to screw his employees, and our firm would probably not do business with you." Me: "Oh, I am not greedy." Him: "Great! So, $5 million post minus $1 million investment leaves $4 million Pre, reserving 20% of the post for employees, means you have $3 million in equity in this company." Me: "Waitwaitwait, that sounds..." Him: "That sounds like I just made you a millionaire. Son, you don't want to be unreasonable here. This is how business has always been done in the Valley. Besides, 100% of nothing is nothing. Don't worry about a bit of dilution, it happens, worry about that huge pile of money you'll have when you IPO." Edit: I originally wrote it as 20% of the Pre, but checking with VentureHacks suggests that it would probably be calculated as 20% of the post. Easy to screw this stuff up, right? It's almost like it is designed that way...
- lfittl 15y ago
  Indeed, option pools are usually created before the actual investment (and therefore dilution) happens, but the option pool percentage you negotiate is % of post-money (not pre).
- mnutt 15y ago
  One thing I've always been curious about: Why not just have a large option pool, with the condition that in a liquidity event all unused equity in the option pool goes back to the common stockholders?
  - notbitter 15y ago
    Because the common stockholders don't have a seat at the table. Instead, when the company decides to sell, the execs fully dilute the common by granting themselves the remainder of the pool (with acceleration on change of control, of course).
thenextcorner 15y ago
Perfect, something I needed to model out what amount I would need to raise, how to compensate employees and possible co-founder split in the equity. Very helpful, thanks for sharing!
jeffreymcmanus 15y ago
I don't get why this expresses stuff in terms of percentages instead of absolute dollar amounts. I can't buy a house with 15% of a company but I can buy a house with a million dollars.
- lsc 15y ago
  if you own less than controlling interest in a company that has not gone public, my understanding is that you only own anything at all at the whim of the person (or group of people) that does have controlling interest; My understanding is that there is really no way to make it so that the people that own the company, legally, can't screw you if they want. The whole system is based on trust. The smaller your percentage, the smaller your vote, and the less power you have when negotiating with others to form a coalition that would have controlling interest in the company; So yeah, I think your percentage does matter a lot.
  - onemoreact 15y ago
    If you take reasonable precautions. A) There are few legal ways of really screwing over investors. B) You can sue for most of the legal ways. Unforgettably, it's vary easy to screw yourself over when dealing with a start up. But, the real problem IMO is that employ's generally have less leverage and can't afford to sue. "We got an offer that's very good for us and acceptable to the investors. So, sure you get nothing but I don't need to care because this is no longer my company have a nice life."
    - lsc 15y ago
      As for A, how do I keep the majority shareholders from voting to bring in expensive management, rent expensive offices and equipment, then issuing more stock when they run out of money and repeating the process until I am diluted to nothing? I mean, I've worked at many places where that looks like the company plan; they spend all their revenue, which is fine, but then they act like the investment money is revenue as well. It's like they plan for explosive growth, which is great, but they buy stuff that only makes sense if that explosive growth were real, and it ends up killing the company when the growth turns out to be only reasonable. Sure, if the majority shareholders end up voting themselves huge bonuses or spending most of the company money on consultants that happen to be their friends, sure then I can sue them and maybe get something back; but the first case I describe is far more common, and the result, really, is the same.
deleted 15y ago
[deleted]
viggity 15y ago
looks really cool and useful. One gripe: 3D pie charts are evil. http://www.gilliganondata.com/index.php/2009/12/02/how-succinctly-can-i-explain-why-pie-charts-are-evil/ http://www.gilliganondata.com/index.php/2009/12/02/how-succi... Use bar charts instead, or if you're really stuck on the pie chart thing, don't make it 3D
pwang 15y ago
Aack, 3D pie chart... Arguably the worst of commonly-available plot types.

79 points by snampall 15y ago

Note in particular how option pools dilute founders, not investors. My understanding is that is actually negotiable, but it is an easy way for unsavvy founders to have the valuation they negotiate not mean what they think it means. (Ditto not understanding what Pre- and post-money valuations mean.) Example: suppose I, a clueless tech guy, am negotiating with a savvy and aggressive money-guy. Assume for sake of argument we're raising $1 million, and my naive thoughts are that "The company is worth $5 million." Me: "The company is worth $5 million." Him: "We can totally work with a $5 million post-money valuation." Me: "Great." Almost everyone on HN knows I screwed myself. You think I just priced the company down to $4 million, right? Yeah, even worse. Him: "So you know, it is customary for companies in Silicon Valley to make generous equity grants to attract and retain employees." Me: "Oh totally." Him: "The standard is 20%. You could get a lower number, but honestly, you'd look like a greedy bastard out to screw his employees, and our firm would probably not do business with you." Me: "Oh, I am not greedy." Him: "Great! So, $5 million post minus $1 million investment leaves $4 million Pre, reserving 20% of the post for employees, means you have $3 million in equity in this company." Me: "Waitwaitwait, that sounds..." Him: "That sounds like I just made you a millionaire. Son, you don't want to be unreasonable here. This is how business has always been done in the Valley. Besides, 100% of nothing is nothing. Don't worry about a bit of dilution, it happens, worry about that huge pile of money you'll have when you IPO." Edit: I originally wrote it as 20% of the Pre, but checking with VentureHacks suggests that it would probably be calculated as 20% of the post. Easy to screw this stuff up, right? It's almost like it is designed that way...

lfittl 15y ago
Indeed, option pools are usually created before the actual investment (and therefore dilution) happens, but the option pool percentage you negotiate is % of post-money (not pre).
mnutt 15y ago
One thing I've always been curious about: Why not just have a large option pool, with the condition that in a liquidity event all unused equity in the option pool goes back to the common stockholders?
- notbitter 15y ago
  Because the common stockholders don't have a seat at the table. Instead, when the company decides to sell, the execs fully dilute the common by granting themselves the remainder of the pool (with acceleration on change of control, of course).

thenextcorner 15y ago

Perfect, something I needed to model out what amount I would need to raise, how to compensate employees and possible co-founder split in the equity. Very helpful, thanks for sharing!

jeffreymcmanus 15y ago

I don't get why this expresses stuff in terms of percentages instead of absolute dollar amounts. I can't buy a house with 15% of a company but I can buy a house with a million dollars.

lsc 15y ago
if you own less than controlling interest in a company that has not gone public, my understanding is that you only own anything at all at the whim of the person (or group of people) that does have controlling interest; My understanding is that there is really no way to make it so that the people that own the company, legally, can't screw you if they want. The whole system is based on trust. The smaller your percentage, the smaller your vote, and the less power you have when negotiating with others to form a coalition that would have controlling interest in the company; So yeah, I think your percentage does matter a lot.
- onemoreact 15y ago
  If you take reasonable precautions. A) There are few legal ways of really screwing over investors. B) You can sue for most of the legal ways. Unforgettably, it's vary easy to screw yourself over when dealing with a start up. But, the real problem IMO is that employ's generally have less leverage and can't afford to sue. "We got an offer that's very good for us and acceptable to the investors. So, sure you get nothing but I don't need to care because this is no longer my company have a nice life."
  - lsc 15y ago
    As for A, how do I keep the majority shareholders from voting to bring in expensive management, rent expensive offices and equipment, then issuing more stock when they run out of money and repeating the process until I am diluted to nothing? I mean, I've worked at many places where that looks like the company plan; they spend all their revenue, which is fine, but then they act like the investment money is revenue as well. It's like they plan for explosive growth, which is great, but they buy stuff that only makes sense if that explosive growth were real, and it ends up killing the company when the growth turns out to be only reasonable. Sure, if the majority shareholders end up voting themselves huge bonuses or spending most of the company money on consultants that happen to be their friends, sure then I can sue them and maybe get something back; but the first case I describe is far more common, and the result, really, is the same.

deleted 15y ago

[deleted]

viggity 15y ago

looks really cool and useful. One gripe: 3D pie charts are evil. http://www.gilliganondata.com/index.php/2009/12/02/how-succinctly-can-i-explain-why-pie-charts-are-evil/ http://www.gilliganondata.com/index.php/2009/12/02/how-succi... Use bar charts instead, or if you're really stuck on the pie chart thing, don't make it 3D

pwang 15y ago

Aack, 3D pie chart... Arguably the worst of commonly-available plot types.