Cap table scenario to minimize dilutive fundraising

I am working on a start up with some friends and am trying to model out a scenario for our cap table. Let's say we are taking in investment for the first time ever and that we are raising at a $10M valuation and are offering 20% equity for $2M in capital. Let's assume our valuation doubles in 12 months to $20M and we want to raise an additional $2M of capital but didn't want to dilute the early investors. Can we simply offer the second round investor capital from our 80% stake and retain the early investor's equity position without dilution? Does this ever happen in practice?

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Comments (6)

Oct 11, 2021 - 10:45pm

So you'd be eating all of the dilution instead of the investor in the first round? That's not normal at all in today's market. Maybe 5 - 10 years ago but your investors tend to eat dilution equally unless they have baked in downside protection...which is not nearly as common as it once was.

I recommend Brad Feld's Ventue Deals as a starting point.

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Oct 12, 2021 - 3:16pm

As someone else said you could sell secondary but that wouldn't give you any primary capital for the business.  The other approach would be to grant additional shares to the first investor to protect them from the dilution.  Not sure how that works in practice but would google "anti-dilution protections"

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Most Helpful
Oct 14, 2021 - 8:19am

Chipping in on top of previous good comments. You can finance through a convertible, which only delays the dilution (to all, not only your investors, but also your stake) but hast two advantages: 1) funds for the co and 2) valuation and dilution takes place later on and hopefully atva higher valuation (e.g. less dilution than today). There are a few variations and flavours to it. In addition to the wrong signalling (founders "cashing in early" and "cashing in before investors" ) investors in this or later stages may ask founders to hold a certain level of equity (keep incentive and skin in the game); which may lead to additional conversations and dilution for the cap table. You can also play with the share classes (e.g. convert existing into new ones with a ratio or grant an option to convert to improved conditions) or grant them an economic upside directly from your stakes, but all these gimmicks are generally not viewed favourably by later stage investors. Keep it simple and clean, probably best advice.

  • Associate 1 in RE - Res
Oct 14, 2021 - 2:05pm

These are all great comments. I 100% recognize the optics of cashing in early. In this case we'd actually be looking to have the 80% be held by the company and any proceeds from any sale from this 80% would stay with the business and be reinvested for growth. Would this change the discussion at all?

  • Associate 1 in PE - LBOs
Oct 14, 2021 - 6:23pm

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