Founder Dilution - How Much Is "Normal?" | Hacker News Reader

Founder Dilution - How Much Is "Normal?"

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43 pointsciscoriordan33 comments

This is like an equation where the earlier you go outside for capital the bigger the chance that you will end up with a very small slice of your company and a possible lack of control.

If you're halfway smart - and you'd better be if you plan to play the game well - then you should stretch your own means as far as you can. If you're dirt broke and you want to start a new company it better be something that is profitable within 30 days.

If that is not in your future then consider doing two things, one with a short ttm to fund the other. That way you can develop your 'big idea' to the point where you've proven its merits by having your first batch of users on board or whatever metric you use to measure your success.

The worst way to start a new company is to just have an idea and to start looking for funding. By the time it is a running business you'll have nothing left.

No point in blaming the VC's for that, an idea is just that, an idea. I have a notebook here that contains a bunch of ideas. Each and every one of those is potentially a company worth some money if you put in a couple of years of sweat and brain power. Without that they're just ideas and I personally value them at exactly $0.

edit:

Another really good reason to go the 'spend your own $ first' route is that you show with your own money that you really believe in your idea, that will go a long way towards convincing people that you are serious.

Agreed. I wrote some of my thoughts down recently here: http://david.weebly.com/1/post/2009/02/does-capital-efficien...

Essentially, while running a grossly underfunded company is definitely bad, that's not to be confused with a "raise insane amounts of money and spend it indiscriminately" attitude.

Doing the most with the least amount of money is still the best way to maintain maximum ownership, but it should definitely be balanced against the risks of not being properly capitalized, where "properly" is certainly open to interpretation.

I even think that some initial funding constraints will sharpen your wits in ways that nothing else can.

I read your post, and a similarity struck me between your situation and the one I was in with a competitor funded to the tune of 30M US by two very large companies. We were approached with the intent to acquire, but the management team there was - to put it mildly - a little strange, so we declined. After 3 years they had burned through the whole wad and the plug was pulled.

It was the weirdest experience, to out-compete a company that has such enormous backing with a team of very few but very dedicated people in two small offices (one in Toronto, another near Amsterdam).

As a counterpoint, my son and two of his buddies started a company to create a specialized chip. After 6 months they hired a CEO who had founded his own company and sold it for 9 figures (I believe). The CEO got no salary and got stock only if he raised the necessary funding. Six months later he raised mid 7 figures from angels and the founders still had control. They have since raised another similar round from angels.

Interestingly, they used VC's to recruit the CEO, but not for the money.

For companies that need significant teams and years to get traction this is a reasonable model that has worked for years. The VC’s are optimized for plays that have 10’s of millions in and 100’s out.

There is a new breed of companies that are far more nimble and don’t need 10’s of millions in. The main issue for these companies is how do they extend the team and get the (limited) capital they need to execute the business beyond the product.

At Tandem Entrepreneurs we have a model that works for such companies (there are probably others models out there as well).

We serve as the extended team for founders. The result is that the founders get to keep a much larger chunk of the company as the extended team doesn’t add burn. We also serve as the investors so there is no time wasted raising money or hiring.

20-25% for the management team? Perhaps MBA's aren't as "useless" as some folks preach they are. Just being qualified to be one part of this team puts you on an equal footing with founders in a startup after 4 rounds. Damn...

Who are these people? I am assuming that CEO/CTO are the founders, then you recruit COO, a VP of marketing, perhaps VP of business development... who else? Do these 3 new folks grab 20% of the company in addition to being paid salaries?

since they say its a late stage play, my guess the founders are pretty much kicked to the curb by this point. So CEO is most likely in play.

He probably means management team + other employees. Isn't the total employee option pool about 20%?

Yes - in the comments he states the 20-25% includes all employees.

One interesting answer was to "Let's say the 2 co-founders (1 engineer 1 business-type) have just gotten $100k angel and are hiring an engineer. What sort of equity range for that engineer would you expect."

The answer was "1-2%". It's unclear if that's 1-2% at exit, after the first VC round, after the angel round, before the angel round, or what.

Even if it's 1-2% at exit ....

> Even if it's 1-2% at exit ....

It's not - it's <0.5% at exit.

And remember, there are usually 2-4 founders.

I have a couple of enterpreneur friends that say that you should always aim for an even number of founders (3 in the best scenario, never 1, hardly ever 5). Having an even number helps when 'voting' things, so the tendency is to keep things moving... having been an enterpreneur myself (with 3 other people), I must agree with them

An odd number you mean?

yes... sorry!

Even further dilution. How important is a 5 million cashout when you only have 7% left of the company you slaved on for three years? I never plan on taking VC money if it is at all possible to avoid.

Percentages are irrelevant, once you've lost controlling share it doesn't matter if you have 49% or 4.9% - as 4.9% of something > 49% of nothing.

Since the percentage you own is also the percentage you can sell later, it certainly isn't irrelevant.

So you'd rather have 49% of a dangerously under funded company than 4.9% of a well funded company?

If you sell equity for investment in to the business the total value of your shareholding has not reduced, but the company is more able to proceed.

Too many shareholders blindly cling to equity for the sake of keeping a high percentage - when the business would benefit from further investment.

Meh. Most companies are "dangerously underfunded" until they're cash flow positive.

This is not really true, but it seems to be a common thought here.

VCs are investing in the whole package of founder+product/idea. VCs, like any other investor, are inherently lazy in that they would much rather that somebody else do all the work while they make all the money.

If you maintain 49%, or even less, of a percentage you would generally only need 1 other board member to be on your side to "maintain control". No board or investor WANTS to go through the turmoil of replacing or fighting with the founders. If they did feel that way, they would likely not invest in the first place.

When the company does finally get to the point that the stock has some real exercisable value, you will wish you had 49% instead of 4.9%, given the opportunity.

I typed-up a long comment, but just decided to submit it instead to YC as a blog post:

http://news.ycombinator.com/item?id=490145

completely unrelated but still frustrating.

i get this message whenever i try and submit something to HN, what is that mean besides the obvious i'm not even submitting fast.

"You're submitting too fast. Please slow down. Thanks." link: http://news.ycombinator.com/x?fnid=EQ89mTm1oN

Two thoughts come to mind:

1) the VC system needs to be reformed. If founders are being screwed like this (and I think it's reasonable to say this is a screw), they're going to find other ways to raise capital. (And they are!) VCs should be in the business of cultivating founders, of encouraging and then rewarding them.

2) This is all the more reason to sell your company; it's more realistic (post-dot-com-bust) anyway, and obviously, it's the way to profit the most. Plenty of companies are buying these days. You just have to find a way to make something worth buying (and that's the rub, isn't it?).

I'm not sure how founders are being screwed here. They are asking for (in most cases) millions of dollars to develop a likely unproven idea. Also, VC's are not in the business of coddling founders. They are making an investment that they hope will return a profit and that is what is expected by their investors. Places like YC try to cultivate and encourage the founders, but they only give you ~$10000. If you want a couple million then you have to be willing to play the game.

You are right in the fact that new startups should be looking at new and innovative ways to fund themselves and I hope that people take that point away from reading articles like this.

They're being screwed: after developing a workable idea and putting years of work into it, they come away with practically nothing. If that's "the game" then no wonder founders are turning away from VCs. That's why I'm suggesting VCs change. Stop short-changing the founders. VCs with no founders are not VCs.

10% of a million dollar company isn't practically nothing.

It's not much when you a) have to split it 2 or 3 ways, and b) have to watch the VCs take home several times as much, when you did all the work.

My point is that there is a value judgement here. VCs are being overvalued, and founders are being undervalued. This serves to demoralize and demotivate the founders, ultimately hurting the value of the company. It doesn't need to be that way.

They are asking for (in most cases) millions of dollars to develop a likely unproven idea.

They're asking for money that can potentially make the VCs very, very rich. Or at least make a good return on investment. The VCs are choosing to make that investment. They're not just being asked; they're answering in the affirmative, at which point they ought to be working in all parties' best interest.

VC's are not in the business of coddling founders.

I think you're making this guy's point. That is the problem. They should be in that business; they'd be helping themselves.

Judging by the number of up-votes, I wonder how many VCs lurk here. They can't be PG fans, considering what PG has had to say about VCs:

http://www.paulgraham.com/venturecapital.html

thing is, you should put the value of money in a more important position. If you are looking for fund, that means your "business" here need more money to start or level up otherwise you can self-fund. Under that circumstance, without the money, you can achieve nothing. To find VC for funding is a fair game in the end (despite somehow the connection plays an important role here). It is a open market, you need money, and they take shares. A business is a business not an idea because someone has to do it and someone actually fund it.

If you just glance at the numbers it looks like they're being screwed. But at each round (while they still had control) the founders got to decide if taking funding would be better for the company and themselves.

There's no rule that says founders get to keep large percentages of their companies.

My point is that it doesn't have to be that way. The VCs are behaving in a predatory way, and they don't need to. I've worked at such a startup, and taking funding isn't just a nice option; usually it's a matter of survival. Of course a VC firm is going to take advantage of that fact. But if they showed a little more character by not sucking up such giant gobs of the companies, the founders would be encouraged to stick around and maximize the company's value. Instead, they're just encouraged to get what they can and then get out.

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