Hacker News Board Hacker News, browsed like a classic message board
Live data from Hacker News

Equity Investment Simulation: Illustrating Dilution

ownyourventure.com

Post reply on HN
Print view View original

1–10 of 15 posts

Re: Equity Investment Simulation: Illustrating Dilution

#2

Post by patio11 »

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...

Re: Equity Investment Simulation: Illustrating Dilution

#3

Post by lfittl »

patio11 wrote: post #2

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 argume…

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).

Re: Equity Investment Simulation: Illustrating Dilution

#5

Post by mnutt »

patio11 wrote: post #2

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 argume…

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?

Re: Equity Investment Simulation: Illustrating Dilution

#7

Post by notbitter »

mnutt wrote: post #5
patio11 wrote: post #2

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 argume…

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?

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).

Re: Equity Investment Simulation: Illustrating Dilution

#9

Post by lsc »

jeffreymcmanus wrote: post #6

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.

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.

Re: Equity Investment Simulation: Illustrating Dilution

#10

Post by onemoreact »

lsc wrote: post #9
jeffreymcmanus wrote: post #6

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.

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 percentag…

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."

Post reply on HN