How dilution impacts the outcome for entrepreneurs and their startups?
Dilution is a major factor in startup businesses. It is hugely influential on outcomes, and in many ways for the founders themselves.
This is also one of the factors which new entrepreneurs frequently overlook in the rush to get going, and the chaos of getting to market and everything else involved. Still, it only takes getting it wrong once to really learn your lesson. Hopefully, that doesn’t come at the cost of the next 10 years of your work.
So, what is the big dilution debate all about? What are the real pros and cons for you and your company? How can you optimize to get more of the upside, and less of the downside?
The Ultimate Guide To Pitch Decks
What Is Dilution In Startups?
Dilution refers to the watering down of equity in startups.
What’s the big deal with this?
The amount of equity you have directly impacts not only voting rights and decision-making ability in a company but also how much of the profits or value of the company really belongs to you.
The more diluted the equity, the less of these things you have. The more consolidated it is, the more you have.
Dilution is most commonly an issue when startups are fundraising, or giving out shares of the company.
See How I Can Help You With Your Fundraising Efforts
See How I Can Help You With Your Fundraising Efforts
What Creates Dilution?
There are a variety of ways that dilution can occur in startups.
The most common and debated is during fundraising, and exchanges ownership and shares in your company for cash. This can be substantial, double-digit percentages of your company during early fundraising rounds.
Stock is also often issued and distributed in recruiting efforts as well. This includes granting employee stock options and creating a stock options pool. As well as giving early key team members and advisors small percentages of the company to encourage them to come on board.
Keep in mind that in fundraising, storytelling is everything. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
The Pros Of Dilution In Startups
Of course, there are advantages to allowing dilution. Otherwise, no one would ever do it, right?
But, you should take the time to understand how dilution impacts the outcome for entrepreneurs. Some of the reasons to embrace dilution include the following.
Bringing In More Capital
If you want to raise equity funding, then you are going to embrace dilution. The more of your company you are willing to give up in the early stages, the more capital you might bring in.
Some startups absolutely must have the capital to get off the ground. As well as ongoing infusions of working capital to stay afloat and keep on growing.
It often comes down to the personal choice of the founders, previous investors, and other shareholders. Though there is also a serious legal obligation and responsibility to do what is best for the company itself.
Bringing In Experts
If giving away a small slice of the company enables you to bring in great experts with superior skills in various core parts of your businesses it can be well more than worth it.
This can apply to advisors, marketing professionals, technology experts, and fundraising consultants.
They can also bring resources, contacts, credibility, and visibility that will make the business. Without them, you may not be able to compete or give your idea the best chances of succeeding.
Being Able To Go Bigger, Faster
Dilution is often a trade-off for the ability to go bigger and faster.
For many, this ability makes all the difference in their ability to survive and thrive. For others, it may just be for maximizing the opportunity currently at hand.
It can afford to lose money to gain market share, make upfront investments, and for developing expensive things that just can’t be possible without large amounts of capital.
Incentivizing Those That Work For You
This isn’t just about recruiting and initially attracting top talent and individuals to your company. It can also be just as powerful for motivating their best performance, and retention.
With shares, their own personal outcomes are tied to the success of the company. If they stay and give it their all, they can reap huge rewards.
If they underperform or duck out early, they could be missing out on millions of dollars, and some pretty life-changing outcomes.
The Cons Of Dilution For Entrepreneurs
Of course, everything that has pros also has cons. Some entrepreneurs are very dilution averse for some of the following reasons. Not being aware of these can mean working for years to end up feeling like you wasted it all. For this reason, you should understand how dilution impacts the outcome for entrepreneurs negatively.
Loss Of Control
The dilution dilemma isn’t only about the money. It is also about control and power over your company.
This isn’t about being a control freak. There are many advantages to leaning on the insights of those that have more experience than you.
However, as you give up board seats and voting rights, you can find you are left with very little decision-making power over the company you started.
You can even get kicked out of your own company. You may be blocked from the ability to sell your company. You may be forced into short-term over long-term thinking. This ruins the dream of building a truly great product, with a positive impact and great customer service. At least unless your only goal is to go huge fast and sell out before it implodes.
Receiving Little To Nothing When Your Company Is Acquired
Dilution can even mean that you sell your company for a billion dollars, and walk away without a penny. It sounds crazy, but it has happened.
You should at least be fairly compensated for your part in all of this and all of the extremely hard work and stress you are certain to go through. Especially when billions are being carved up for others.
Just as equity can inspire and motivate others working with you, a lack of it yourself can really steal your motivation and demoralize you.
If you don’t see much in rewards coming down the line or have little ability to impact that outcome, it can steal your energy and will. That isn’t going to work out very well. It is just going to be downhill from there.
Offering your company stock for sale to raise funding is only one of the ways to infuse capital into it. But, considering the downsides, you should do your homework on how to find investors for your startup. Check out this video where I have explained how to explore this option for getting funding.
The Two Mindsets Around Dilution
When researching how dilution impacts the outcome for entrepreneurs, you’ll come across different facets. Many startup owners are completely oblivious to these issues, and that can be tragic. Though, informed entrepreneurs are typically still split between two main mindsets and approaches to dilution.
One group is bullish on embracing dilution. They want to raise big and go as big as they can, as fast as they can. They are quite happy taking a much smaller piece of a far larger pie.
As long as the mission works out, and they feel that they are fairly compensated then that is great.
The other group is more protective of their ventures. It’s not about the money, but far more about the control they have over their businesses. They at least want to defer and push out dilution longer, and get more value for the money they do bring in.
Both strategies have worked out. Both have also not worked out as well as the founders expected.
Strategies To Optimize For Dilution
There can be a middle ground that you can figure out when learning how dilution impacts the outcome for entrepreneurs. Ways to get the benefits of the activities that can create dilution, while minimizing it, and the negative impacts.
Entrepreneurs typically give up the largest chunks of their companies and end up creating and setting up the most dilution during early rounds of funding. With this in mind, some try to skip seed-stage rounds and delay taking outside investment as long as possible.
Gain More Traction Before Raising
Giving up less of your company, and getting better terms isn’t just about when you raise, or what you call the round. It is about what you have to show.
How much progress you’ve made, how much risk you’ve removed, and your financials all make a big difference in how motivated others are to invest in you, and the terms they will agree to.
Show up strong, and you’ll give up a lot less.
There are alternatives to dilutive equity fundraising too. These include loans and debt financing, asset financing, and grants. They are ways to bring in the money, without suffering dilution.
It doesn’t have to be one or the other. You can start with non-dilutive options, or mix them in.
Pay Salaries Instead Of Equity
Giving equity can be a great way to gain and retain and motivate talent. It can have lots of benefits as an early-stage, lean startup. However, the twist on that is it can be far more expensive later.
If you can afford it you may choose to pay higher salaries, hourly wages, or commissions instead. Even to those who could be cofounders.
Do the full math and see which actually has the best net benefit.
Have A Great Negotiator In Your Corner
Dilution is also greatly about the deal you strike with your investors and other shareholders.
Having a strong Fundraising Advisor on your team will make all the difference in the terms. They know what’s possible and what you should be demanding, versus what some may try to throw out there as an offer to newer entrepreneurs.
They can help you keep more equity, avoid dilution, strengthen your voting rights, work out different classes of shares, and ensure you get the best value for what you do give up.
Sell Your Company Earlier
Rather than committing to endless fundraising rounds and compounding dilution, it may make more sense to exit and sell your company earlier. Then get onto the next startup. Use it to get a windfall of money, gain contacts and experience to work on what you really want to do, without dilution the next time around.
If you are going to dive into entrepreneurship and create a startup, then you need to understand dilution.
Know what causes it. Understand both the pros and the cons of dilution-creating events. As well as what your alternatives are. Then look to optimize for the greatest success of your company, no matter how much you choose to raise, and how fast you want to go.
Mastering dilution will give you a huge advantage. Both in being able to truly see your vision and mission of the company through. As well as to maximize the fruits of all the labor you are going to put in. So, take the time to learn how dilution impacts the outcome for entrepreneurs.
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