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Of course you'll be diluted as the company grows, so the point of asking is not to calculate exactly what your payout will be. But you can use the fully diluted # to estimate your ownership based on average/expected dilution from the current stage to IPO/liquidity.

I.e. suppose a startup grants you 20,000 shares. There is a big difference between the startup having 1M fully diluted shares (2%), 100M (0.02%), and 100B (0.00002%). In the first two cases you're getting a reasonable share of the startup (depending on the stage); in the last case you are likely getting scammed.

I'm not familiar with the shares details and rules governing it, but I've always wondered one thing. Maybe you could please explain to me - how come diluting shares during investment round is legal? Shouldn't all shares of a startup equate to 100% and then any investor just buy parts of that, from the founder's share? Like round A, HSBC buys 20% of the startup and owns 20% and founders(s) 80%. Then round B, JPM buys 25% of the startup on owns 25%, HSBC owns 20%, and founders own 55%. And so on.

With dilution it seems that new shares are spawned and every round and more, and so every original owner automatically looses parts of his share even without selling it? I understand that it is legal in the letter of the law. But isn't it basically a scam in the spirit of the law? Or am I missing something?

Short answer: read the contracts, everything is being done legally.

Slightly longer answer: Let's say you own 1% of a $80MM company that raises $20MM. Your shares were worth $800k before and they still are (0.8%100MM = 1.0%80). The hope/expectation is that money will allow the company to grow its valuation -- if they do, you shares become worth more.

(What you could complain about is the CEO valuing the company too cheaply but there's a huge amount of luck and guesswork and you are missing so much information).

One is giving the founder money, the other is giving the company capital.

> the company has a private post-money valuation of $10B and then IPOs to a stable $10B market cap.

If that’s the case, and they issue 100M new shares on IPO, then the IPO is effectively a serious “down round” that halves the value of all shareholders pre-IPO.

More realistically would be that the post-money valuation after IPO is $20B or more.

you're right that in any funding round (private or public ipo) there is dilution. your ownership in % will go down.

however no company will be able to predict future dilution so this is not really something they can tell you with confidence.

the only thing you can do is gauge current state of the company (funding, readiness for ipo) and try to estimate future dilution but even this is non trivial for early stage companies.

You’re not missing anything. Dilution is destruction of other shareholder equity . It means shareholders without voting rights have effectively no idea what share of the company they own. And even for shareholders with voting rights, it allows other shareholders to steal their equity.

But capital holders (investors) don’t care, because they hold the power in venture backed companies.

Yes, you can't just take your percentage of private shares and multiply it by the private valuation to estimate your IPO payout. But there are two reasons. The first which you identified: dilution. This happens at _each_ fundraise, because the company has to issue new shares, so your % will go down at each funding round.

The second reason is that the valuation of the company changes (typically, it should go up at each round, but in our current climate, down flat-rounds are very likely for many companies).

So your % ownership should go down, BUT if the valuation goes up by the right amount, the value of your ownership should go up too (ie your price-per-share goes up).

The IPO is simply a funding round.

Like any funding round, there is dilution.

The value of your equity is premoney_percentage x premoney_valuation or postmoney_percentage x postmoney_valuation.

As you say, don't make the mistake of premoney_percentage x postmoney_valuation.

If the company sells $5B in stock, the value of the company should increase to account for $5B in additional cash holdings. That still gives a smaller payout than the pre-IPO estimate, but it’s a lot closer.

Definitely not. There's also lock-up periods to consider.

https://www.investopedia.com/terms/i/ipolockup.asp

Not to mention, you probably don't hold shares, you hold options, unless you were clever/daring/solvent enough to exercise early. Substantial dollar amounts involved, and big tax implications.

So really it's a question of what the share price is when you're eventually allowed to sell shares, minus the cost of options exercise.