Understanding Equity Dilution and its Impact
In my current role as SVB’s Managing Director of Early Stage Startups, I’ve been educating founders on equity dilution for years. The following is a summary of my article on understanding the impact of equity dilution as you prepare to raise funds to grow your business. In the article, I spell out details of the different financial instruments available to you and the risks of dilution that you and your early investors may face as a result of using them. You can also read the entire article on SVB.com or listen to it as a podcast.
Fundraising is a major achievement for any founder, especially at the earliest stage. However, founders need to approach every successful round of funding not just as a cause to celebrate as they propel their company forward, but also as a moment to reflect on the downstream implications.
If you are a first-time founder, you need to accurately assess how much money you should raise and which financial instrument you should choose. These decisions are critical to ensuring that the ownership position for you and your investors is protected from unnecessary decay as you fundraise to grow your business. That is why I wrote the article, How Equity Dilution Impacts Early Stage Startups.
In the article, I cover essential topics in detail, such as the difference between a convertible note and a SAFE (Simple Agreement for Future Equity). Also, as you consider various financing instruments, you’ll want to consider using caps as protection from giving away too much of your equity early in the fundraising process. To further help you visualize how convertible notes, SAFEs, and caps all work together, I also layout a couple of scenarios complete with tables and figures that can help as you start to engage in conversations with investors.
The more you learn the basics of fundraising and understand the mindset of investors as well as how VC economics work, the tools available to help forecast and understand long-term equity dilution will become more useful to you. That is why I provided links to download SAFE templates and more online sources to assist you with fundraising and dilution in my full article.
In my article, I also cover the following topics:
· Why it is important to accurately calculate how much money you need and not fall into the trap of raising too much.
· Why relying on convertible notes for too long may subject you to needless pressure on raising a high-value round.
· Why caps can be good protection in avoiding downstream dilution.
· Why super pro-rata rounds run the risk of stifling future investment in your company.
With so much to consider, it is always good to understand your options. I hope you’ll enjoy reading my full article as much as I enjoyed writing it!
