Equity dilution works when the same pie is divided among more people. When the Founder of a company starts by owning all the shares but over time, other people receive pieces of equity in exchange for work (employee stock options), money (seed, angel and venture investors), services (attorneys, directors). Because the total percentage of equity will always equal exactly 100%, every time anyone gets another piece, by definition it "dilutes" all of the previous equity holders.
The biggest concern for all investors, and entrepreneurs is equity dilution. If you dilute the equity too much and too early, then later investors have no incentive to invest.Of course, all of this is an oversimplification of the process of valuing a startup company, but it can serve as a guideline for new entrepreneurs.
ADVICE for startup
- Do not get desperate.
Not every early investor is sophisticated or prepared enough to understand the importance of protecting against dilution. You may find yourself faced with an investor who is willing to invest a large sum of money but has unreasonable demands. As tempting as it may be, do not sacrifice to the point where it affects your long-term goals.
- Remember that everything is negotiable.
There are always creative ways to structure deals and contracts that will make all parties comfortable. Be willing and flexible to entertain ideas, as long as they do not compromise these early-stage fundraising tips.
Be open to any investors propositions so you can answer back, adapting it to the startup’s business plan and market.
In the end, remember that raising capital for startups is a long and difficult process.
Try ii out! Put yourself in the shoes of investors, and remember that patience, honesty and determination will ultimately help you meet your fundraising goals.