>All things being equal, owning more % of a company == more money.
The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.
If it helps, think of "dilution == sell_equity". Dilution is the perspective of the sellers' side (x% - y%). Equity purchased is perspective of the buyer's side (investor's ownership goes from 0% to y%).
>To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.
Dilution explanation doesn't require "spin" nor mental trickery. It is the natural side effect of how companies sell equity to grow.
E.g. Larry Page's ownership of Google Inc got diluted from 50% in 1998 down to 16% in 2004. That smaller 16% was worth ~$3 billion around the time of the IPO[1]. If Larry insisted on "no dilution", no VC would invest money to help the search engine grow and therefore, he would own 50% of a worthless company.
So all things not being equal:
50% of $0 = $0
16% of $20 billion = ~$3 billion.
Obviously $3 billion is more money than $0. Thinking that 50% is better than 16% doesn't make sense for companies that require outside investors to grow. Similar story for Bill Gates' dilution, Jeff Bezos' dilution, etc.
Let's imagine Larry Page had a different conversation with Sequoia Capital to match this misunderstood fixation over "anti dilution"
>1998: Larry owns 50% + Sergei owns 50% = 100%
>1999: Sequoia: "we'd like to buy 10% of Google Inc for $12.5 million"
>Larry responds: "Yes! Great! We need your $12.5 investment but keep in mind that both Sergei and I have anti-dilution clauses so our ownership both stays at 50%."
> Sequoia responds, "So you want me to buy 0% of the company for $12.5 million? Uh, you guys are idiots"
Somebody in that imaginary conversation doesn't understand "dilution" or "equity" or simple math.
Sure, but dilution without representation can be a big risk for a regular employee. You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.
If you have no say over how much you're diluted (like most employees), you could be diluted away to nothing. You have no control. So you must calculate worth accordingly.
Is everyone to get diluted equally. No? Well then, calculate worth accordingly.
In addition, I thought the pie getting bigger was the WHOLE POINT OF HAVING THE SHARES TO BEGIN WITH.
>You might get a smaller slice of a bigger pie, but it may also represents a smaller real-world valuation if you get diluted too far.
Show example math of how someone could get "diluted too far" resulting in less total value (shares x price) after an investment round that prices the company higher than before. If the total value was truly less, it means it was "down round" which is a different beast.
>, you could be diluted away to nothing.
Show how it is mathematically possible to dilute employee's 1% ownership in to 0% without illegal tricks.
When Mark Zuckerberg tried to dilute Eduardo (without also diluting the other owners), he tried to hide the reduced % via a newly created company. He got sued for the financial deception and lost.
I'm somewhat new to this topic (and therefore might not understand correctly) but another user, 'oillio', made a response in a different thread [0] which could explain 'getting diluted away to nothing', for example, an investor invests money causing dilution, the company squanders the money or uses it on something that doesn't positively affect the company trajectory. You now own a smaller slice of a pie which is the same size as it was before.
Using his example, if you estimate the value of a company to be 100M and estimate 10 years until IPO, if the investment doesn't raise the value of the company at the time of the IPO in 10 years then the dilution is not good for the employee because the pie is the same size (100M) but his/her shares have been diluted.
Seems like it's pretty difficult to estimate the value of the company in 10 years or the IPO date though which is probably why people just use the amount invested to estimate the value of the company.
> Sure, but dilution without representation can be a big risk for a regular employee.
Well, it's a big risk to everyone that doesn't get voting rights, right? Not all investors get voting rights, do they?
In some way, an employee sits between a non-voting investor and a voting investor. They don't get to vote, but they do have some control over the outcome of the company (ranging from small to large, depending on the number of employees and responsibilities of the person in question).
I didn't say anything about anti-dilution.
There are complexities, but as you explain, if you take more money, you need to give the investors something.
If you look purely at the accounting, and ignoring voting rights and other complications, you are right. Dilution doesn't change anything.
IMHO this argument is a case of technically accurate, and completely useless.
It doesn't matter what the value of the company is at the moment of the dilutive event. It matters how that event affects the value of the company when the employee liquidates their stock.
The new round could be very good, but not necessarily. There is no guarantee a more well capitalized version of the company will end up growing faster or larger than the current cap table.
When the employee evaluated their original option grant they should have done an analysis of the business, its market, and future growth potential. Lets say the predicted value of the company is $100M in 10 years.
Lets look at two options:
Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.
The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.
Option 2 - The company has identified a new market opportunity. They are raising capital to spin up a new project and capitalize the opportunity. If successful, the company now looks like a $10B company in 10 years.
The new round is potentially good for the employee. On liquidation, they will have a little bit smaller piece of a much bigger pie.
> Lets look at two options: Option 1 - The company is continuing on its original trajectory. It is running low on runway and needs a cash injection to continue gaining market share for its quest for profitability. The company still looks like a $100M company, if successful.
>The new round may not be good for the employee. When you look forward to the eventual liquidity event, the employee now has a smaller piece of the same sized pie. Maybe the company could still reach its goal by tightening its belt a bit.
Sure, but not taking the extra round is also bad for the employee, right? If you don't take the round, and the company now looks like a $50M company, then you have the same piece, of a much smaller pie.
>IMHO this argument is a case of technically accurate, and completely useless.
Actually, your statement of "All things being equal, owning more % of a company == more money." ... is what's misleading.
People are cargo-culting the meme that "dilution is bad" and it has the perverse effect of making them think that awareness of it is "financial sophistication."
Your other statement, "Mostly from people trying to sell the idea of a highly dilutive funding round." ... is also misleading.
It's not the "dilutive" effect that's the core issue. It's whether the company needs the funds. If the company needs the investment, it needs the investment. The dilution is a side effect.
If the new investors want too high of a percentage-of-ownership, then yes, it's "highly dilutive" which is tautology. This may also appear like a dilution problem but it's not. It's a financial literacy problem.
The founders are supposed be smart and not sell too much of the company for too little a price! Therefore, I'm not talking about desperate situations of founders getting diluted down to 10% or less which then affects their motivation to run the company. In that case, the company is probably in financial trouble and the other option is to reject the investment which lets employees maintain a non-dilutive ownership of a bankrupt company.
>The new round could be very good, but not necessarily. There is no guarantee [...]
I agree but the backlash against dilution is about expectation of future events whereas your scenario is ex post facto judgement of past outcomes.
For a startup operating in the present moment, do the employees want the company to be able to raise equity financing to help navigate an unknowable future?!? If yes, it means everybody should expect some dilution in exchange for the outside investment.
>Lets look at two options: Option 1 [...] Option 2
Again, for both of your options, the easier and correct focus is shares multiplied by price. In the bad outcome of Option 1, the price went down. In the good outcome of Option 2, the price went up.
Focusing on dilution as some scary boogeyman is backwards since everybody else gets diluted (see Larry Page, Bill Gates, Mark Zuckerberg, etc)
Again, to reiterate the Larry Page example:
- Focus on the $3 billion vs $0. This is shares * price. The price is embedded in the "all other things being equal" part that you dismissed. The price is "not equal"!
- Don't focus on the dilution from 50% vs 16%. You can't play a mental game of "if Larry got 50% of $20 billion, that's $10 billion not $3 billion" because for him to keep 50% (dilution is bad), you have to replay history with him attempting to build Google with zero outside investment. It's more likely he'd have a bankrupt company instead of a $20B company since he can only buy a handful of servers by maxing out his credit-cards, and have no money to hire extra employees. This is the literal application of your "all things being equal". That's flawed ex post facto analysis which doesn't take into account the timeline and reasons people choose to dilute ownership / sell equity to capitalize the company at different stages.
If dilution is bad for the employee, then it is also bad for everyone else. If as you say, "the new round may not be good for the employee", then it also means it's not good for the founders and previous VCs. If the founders are not crooks, the intention for the investment round to help make the company better, not worse.
I still think the main source of outrage about dilution is that people think only the employees get diluted. They don't realize that every owner of the company including founders like Larry Page and VCs like Sequoia will get diluted too. All the sentiments of unfairness flow from that fundamental misunderstanding.
> If the company needs the investment, it needs the investment.
Agreed, but it might not. The fact that it is taking the investment does not mean it is needed, or that it is good for all stakeholders. Investors, founders, and employees all have different goals, motivations, and risk profiles. It is also very possible for the board to make a mistake and take funding that is a net negative for the company as a whole.
My problem is with this argument from your original post:
> In fact, dilution is a positive sign.
These are complex situations. Boiling them down to dilution is good, vs dilution is bad just leads to misunderstanding. Which, in my experience, can be the goal of the person making the argument.
I never said dilution is bad. My original comment was in response to your blanket statement that dilution should be assumed to be good.
I am just saying, "Hold on. It isn't so simple."
In the end, I think we are in violent agreement. People should not get hung up on dilution, it a natural part of the startup lifecycle. It is a factor in the equation, but only a factor. As I alluded to originally, it is much more important what the company is planning on doing with the funds.
Personally, I think the outrage about dilution is due to the fact that many new employees don't take the time to fully understand how it all works when they are hired. The single most important thing employees need to understand about dilution is that, if they join an early startup, it will probably happen at some point. Options for 1% of the company doesn't mean you will own 1% at the end.
Sure, dilution can be a good thing, but that doesn't change the fact that it can also be a gotcha.
> The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.
Right but if you aquired your shares under the assumption that you would own the same percent of a more valuable company, you are still being taken advantage of.
>but if you aquired your shares under the assumption that you would own the same percent of a more valuable company,
The employee shouldn't have that assumption. The correct default assumption is that the employees are diluted just like the founders when new equity is sold.
If the founders mislead the employees into thinking they got 1% -- and it would always stay 1% all the way to IPO, that's an issue with the ethics of the founder and not an issue with dilution. Dilution wasn't the problem. It's the dishonest entrepreneur that's the problem.
Put another way, if a founder told me I would be awarded 1% in stock and it would have anti-dilution protection for all subsequent rounds, I would not think to myself "wow, that's great!". Instead, that would be a signal that the founder is either 1) incompetent with math or 2) a crook.
Right, but if you read the post that you originally started arguing with:
> I started off once thinking "yay, X% means I get X% of the company!" and then I found out the shares can be diluted. Then I learned "non-dillutable".
Then I learned about vesting periods, windows for exercising options, and a whole slew of financial terms and devices; each one seemed to come with its own unique "gotcha" that, if you didn't know about, would cost you nearly everything.
Everyone I talk to about these always says "well, don't do that one thing, or if you do that one thing be sure you do it in this way and you're set". The cumulative knowledge you need becomes pretty high pretty quickly though, and the chances of me doing the right legal and financial incantation at the right moment becomes lower.
Nowadays I go with cash. I don't get 'golden handcuffs' that hold me to a job I don't like because it might pay off later. I can calculate the expected value and risks with cash without tons of research. I know my legal recourses if I get screwed out of cash.
>The cumulative knowledge you need becomes pretty high pretty quickly though,
Yes, I agree that we all go through an early period of ignorance and then we get more financially savvy as we learn more information. We don't know what we don't know.
However, when OP writes, "then I learned "non-dillutable", he/she is misinforming people with expectations that employees can get fixed-percentage ownership that stays at that fixed amount through subsequent investment rounds. The implication is that employees who didn't get such "non-dilutable shares" are getting screwed. This is not the case.[1] The normal situation is for _all_ ownership to dilute. It's not a nefarious trick on the employees.
If people think they are more "financially sophisticated" with knowledge of "no dilution" shares, they are wrong. Instead, if candidates try to negotiate "non-dilutable shares" with a founder as a condition of employment, they will look like clueless idiots. (Reading about mythical "non-dilutable employee shares" on HN made them dumber, not smarter.)
The expected mathematical mechanism for employees to get richer is for the share price to increase instead of the ownership % not to dilute.
Google example is a bad one as most startups fail in practice within few years. Most likely one works in one of those, not at the next business success.
In a typical startup a dilution means that the company run out of initial investments and has no way to get some form of a loan. So selling the ownership is the only way to continue. And if they succeeded with that it would not make the company more valuable. It just meant that owners were good at convincing investors. This is orthogonal to future value of the company.
Nothing so long as a small number of people own all the shares, they all agree to sell an equal portion, and the share price allows an equal portion from all owners.
The point is all things are not equal. To restate a sibling comment, dilution means you own a smaller % of a more valuable company.
If it helps, think of "dilution == sell_equity". Dilution is the perspective of the sellers' side (x% - y%). Equity purchased is perspective of the buyer's side (investor's ownership goes from 0% to y%).
>To try to spin dilution in any other way is stretching the truth pretty far, and is rather manipulative IMHO.
Dilution explanation doesn't require "spin" nor mental trickery. It is the natural side effect of how companies sell equity to grow.
E.g. Larry Page's ownership of Google Inc got diluted from 50% in 1998 down to 16% in 2004. That smaller 16% was worth ~$3 billion around the time of the IPO[1]. If Larry insisted on "no dilution", no VC would invest money to help the search engine grow and therefore, he would own 50% of a worthless company.
So all things not being equal:
Obviously $3 billion is more money than $0. Thinking that 50% is better than 16% doesn't make sense for companies that require outside investors to grow. Similar story for Bill Gates' dilution, Jeff Bezos' dilution, etc.Let's imagine Larry Page had a different conversation with Sequoia Capital to match this misunderstood fixation over "anti dilution"
>1998: Larry owns 50% + Sergei owns 50% = 100%
>1999: Sequoia: "we'd like to buy 10% of Google Inc for $12.5 million"
>Larry responds: "Yes! Great! We need your $12.5 investment but keep in mind that both Sergei and I have anti-dilution clauses so our ownership both stays at 50%."
> Sequoia responds, "So you want me to buy 0% of the company for $12.5 million? Uh, you guys are idiots"
Somebody in that imaginary conversation doesn't understand "dilution" or "equity" or simple math.
[1] http://www.nbcnews.com/id/5033780/ns/business-stocks_and_eco...