What Founders Need to Understand About the Impact of Fundraising on Equity
Last year, we wrote a story focused on giving entrepreneurs a framework for assessing whether to raise a round based on one underlying idea: taking on capital has a cost and an inherent risk. Recently, Pitchbook released new data building on this point further. The data, which was taken from 380 private venture-backed companies, clearly showed the effects of founder dilution over time.
Namely, the average tech company founder saw ownership decline from 60% at the seed stage to under 20% by the late-stage. In a best case scenario, the company’s value increases throughout the process, meaning that less stake still results in favorable returns for everyone on the cap table, founders included. However, if that value does not significantly increase in proportion to capital raised, the founders can find themselves in an unfortunate economic situation.
“Entrepreneurs need to educate themselves around the impact of taking capital as they grow their business. Really understanding how ownership changes each round will help them better position themselves,” said Hyde Park Angels managing director Pete Wilkins.
While the startup trajectory is often outlined as raising progressively more capital until exit, this often does not account for how founder equity will change over time as a result. Later-stage companies require more and more capital, requiring greater founder dilution, and ultimately, the exits may not equal the proportion of work, effort, and time founders themselves invested.
As HPA leader, Co-Founder of Truss, and Co-Founder of Trustwave Andy Bokor put it, “Before embarking on the venture route, I think it’s important to calculate what valuation you hope for with each raise and how much you plan to give up in equity. You can estimate the point of crossing over from owner to employee and weigh the options.”
As an entrepreneur, it’s critical to understand what a “win” actually looks like for you. What will the economics actually need to be for everyone to get a positive return? Asking this question honestly may lead a founder to conclude that a $20M exit might end up benefiting more people than a $50M one in different circumstances. On the flipside, that unicorn IPO may in fact be the best situation for all involved. Context and individual circumstances matter.
“Not every company can be a unicorn, and for first-time entrepreneurs, taking an earlier exit can mean getting better returns and the experience they need to go and do it again. It’s about calculating whether your business can reasonably get to a 10x return every time you raise capital. The answer might be ‘yes’ at the seed stage and ‘no’ three rounds later,” said Jeff Kleban, Hyde Park Angels member and co-founder of Syclo, which exited to SAP in 2012.
(Image via Pitchbook and Wiki Commons)
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