Strategy · Fundraising

How much dilution in share ownership of my company should I give up to investors in my business?

Rohit Prashar Student at CT Institute of Engineering Management and Technology

November 11th, 2016

I have been thinking about this lately. We are trying to launch a new product so we are thinking of securing some of our finances by issuing shares. In case this new product doesn’t prove successful it could cause damage also. Could you share your experiences about this? How much dilution in share ownership should I (as an owner) give up? Is this smart thing to do?
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Mike Moyer

November 11th, 2016

There is only one way to do this right. It's called Slicing Pie and it's a formula for determining a perfect equity split. All other advice you will get is based on guessing and estimates and rules of thumb and predictions about the future. 

Think of your startup as a gamble. If you are the only one betting, you deserve all the winnings. That is an unambiguous reality. But what is more people are betting on the same game? If you and I each bet $10 for a total bet of $20 we should split the winnings equally because we placed equal bets. If you bet $90 and I bet $10 you should get 90% of the winnings. In other words, a person's fair share of the winnings should be based on that person's share of the bets.

Startups are no different. Winnings represent profits or a company sale. People place "bets" in the form of money, ideas, time, relationships, facilities, supplies, equipment, etc. The value of the bets is equal to the fair market value of the contributions.

This is the essence of the Slicing Pie model.

The future of a company is always unknowable. The fair market value of the contributions is always knowable. You should always based the split on what is knowable.

I've written a book on this topic and  you may have a copy if you contact me through SlicingPie.com

Martin Omansky Independent Venture Capital & Private Equity Professional

November 11th, 2016

Yours is a difficult question to answer because there is no information on the amount of money that needs to be raised, and many other factors that go into a valuation. The best short answer is that you should raise initial amounts of capital using convertible notes. Those instruments "loan" you the money needed, and then when the next round of capital is raised (presumably when you have more made significant progress), the holders would convert their notes into equity at a valuation equal to the later investors - minus a discount (typically 15%-29%) to compensate them for taking an early risk. A securities lawyer can advise you on this matter. On the general question of whether or not it is wise to sell shares in your venture, the answer is as follows: (1) use your own money as much as possible, but don't borrow such funds from banks or lending institutions; (2) use your own money, but limit your contribution to funds you are willing to lose in their entirety or you have no access to for long periods of time; (3) investor funds are often used to provide needed financing, but please be aware that the earlier in the life of the company, the more expensive, in terms of the equity you must exchange, it will be for you; (4) even if you sell less than a majority interest in your company, please be aware that the terms and conditions of such an investment (typically set forth in a "Preferred Stock Agreement") will usually limit your freedom of action; (5) funds from strangers usually are not invested in pre-revenue companies or for the purpose of supporting product development; (6) there are some exceptions to Item (5), but typically such funds support expensive, long-regulatory path ventures (life science projects especially) and/or very large market opportunities.Local conditions, laws, and tax policies in various jurisdictions may adversely or positively affect the foregoing answers.

Tom DiClemente Management Consulting | Interim CEO/COO | Coach

November 13th, 2016

It would be helpful to know the type of startup, the stage of your first product, how much money you are looking for, and all of the data an investor would need to have to evaluate a potential investment, of any sort.

I will assume that you are seed stage and have no idea how much money you will need. Supplement your information if these are incorrect.

First, do not start by looking for investment but look for all available government, institutional and corporate grants, and partnerships with corporations who may have an interest in the technology or in selling the final product through their channels. The former group will likely not look for equity or seek only some warrants and the latter group will probably ask for some equity but it will usually be smaller than a typical financial investor.

Second, if you do need investment, aside from the range, a successful investment by a professional will usually require giving up about 30% of the company. You can calculate it all different ways you want, you can use any formulas, but a professional deal will usually be about 30%. 

But you will find few professionals willing to do a seed round with a product that appears to be not ready. Your best bet may be angels and you may be able to do a deal for less equity with angels. 

And don't forget Arthur's comment just earlier. You can also try to reframe the deal. Arthur suggested taking money in return for a share of the revenue which is one viable alternative. Many high roller angel investors in fact tend to prefer this these days. An adjunct to that is that you can combine that with a cap in dollar terms at which time the cash stream as a percent of revenue converts to equity at a preset rate.

Because I think you are at a very early stage with commensurate higher uncertainty than even the normal startup, think in terms of changing the shape of the deal, whether in the direction that Arthur suggests or in other ways that are different than straight equity.

Thanks, Tom

Mike Moyer

November 13th, 2016

Martin,

If you're referring to the Slicing Pie formula, it accounts for all contributions, not just cash. It rewards innovators fairly based on their ideas and their time commits and other inputs. It is an all-encompassing model.

Chunks of capital from Angel investors can be raised using convertible notes or they can use a basic loan structure that allows them to skip payments in exchange for a perfectly fair slice of the pie.

I encourage you to take a look at The Slicing Pie Handbook

Arthur Lipper Chairman of British Far East Holdings Ltd.

November 13th, 2016

Again, there is no reason to offer equity when a royalty is a better deal for both the investorr and the company you are forming. See www.Royalties.Website.

Roger Brown International Business Leader, Technology, Oil and Gas

November 16th, 2016

My advice is that you take up Mike Moyers offer and get a copy of Slicing Pie.   
Fixed equity splits are wrought with peril and difficult relationship management issues.  

Get people to earn their fair equity split through quantifiable contribution.  

Michael Leeds CEO & Founder

November 11th, 2016

Here is a post you might want to review @ https://www.quora.com/What-is-a-reasonable-percentage-of-equity-that-I-should-expect-to-give-up-to-an-angel-investor-in-exchange-for-their-investment 

Arthur Lipper Chairman of British Far East Holdings Ltd.

November 12th, 2016

Whatever amount you give up you will regret if the company is successful. Why not sell them a share of revenue instead of an equity diluting security? See Royalties.Website. Arthur

Martin Omansky Independent Venture Capital & Private Equity Professional

November 14th, 2016

Mike: I am familiar with the slicing pie formula. It does not factor at all for the commercial significance of an idea, nor of the risks undertaken. In fact, these are often unknown by anyone. There is no substitute for business judgement, experience, intelligent guesswork, comparables, due diligence, and a statistical certainty that none of these factors are governing. Sorry, Mike, but we humans are still flawed beings, and, after all, we devised the slicing the pie software in the first place. And, of course, I haven't even mentioned "ego", which often supersedes any formula. Sent from my iPhone

Mike Moyer

November 14th, 2016

Martin: please contact me through http://slicingpie.com/game/. I would like to send you a free copy of the Slicing Pie Handbook.

Slicing Pie absolutely reflects the value of ideas and it accounts for risk and seamlessly manages splits in spite of the unknowns.

Don't worry, there are still places where flawed humans and egos can supersede the fairness of the model. Nothing can protect founders from jerks.

It is still the best defense against unfair splits.