Last week, I introduced our new Capital Calculator app and explained that it can calculate the dilution to the founders’ ownership stake and the distribution of proceeds in a hypothetical exit event based on to certain assumptions. But what exactly does that mean? In this post, I’ll cover the dilution aspect.
The Capital Calculator can help answer this fundamental dilution question:
How much will you the existing shareholders be diluted when they take on an equity investment?
Dilution is the change in a shareholder’s percentage ownership that results from the company issuing additional equity.
In a scenario where there is only one founder at the time of the proposed investment, the dilution calculation is pretty simple. For example, if there is one shareholder with a pre-money value of $4 million and a proposed investment amount of $1 million, the company, after receiving the investment, would have a post-money value of $5 million. The investors, having contributed $1 million, collectively own one-fifth or 20% of the company (the $1 million investment amount divided by the $5 million post-money valuation), and the sole shareholder would experience a reduction in percentage ownership from 100% to 80%, in other words, the founder was diluted by 20%.
But what if the company has a pre-money value of $4.25 million and the investment amount is $1.33 million? Or what if there will be an option pool or there are outstanding convertible bridge notes that need to be taken into account? How does a founder’s ownership change if there is a 15% option pool rather than a 10% option pool? How does a founder’s ownership change if the pre-money valuation decreases from $5 million to $4.5 million, etc.?
The Capital Calculator allows users to manipulate these variables, and calculate the relative distribution of ownership among the various constituencies in the post-money cap table, all within seconds – allowing founders to assess and understand the impact of any changes in these variables as they consider their financing options.