Most founders contemplating a large €20m+ investment round immediately calculate their percentage ownership ‘post-dilution’ (meaning what they owned immediately before the funding round, versus what they own the second after it closes).
This dilution obsession is understandable; it’s a tangible yardstick of how much the founders still ‘matter’ in the company they created. And dilution is real and immediate; you may have raised more than you ever expected, and have a better chance to win in the market, but you are certainly a smaller shareholder in your business the day after.
Dilution is actually far down the list of real value drivers. By far the biggest driver is the growth/capital relationship. Raise more, grow faster, and founders are far better off.
Two scenarios spell out the math (and yes, its all dependent on the assumptions, which are set out in the attachment, feel free to download it!). Lets assume we have a company (“COMPANY X”) which is worth €100m, can raise money successfully, and where the founders own 35%, with investors owning the remaining 65%.
Scenario 1 – COMPANY X raises €10m, all to fund growth. Let’s say there is one new investor who buys in at the €100m valuation, and so owns 9% after investing. Selling COMPANY X in 3 years nets the founders €26m under our assumptions.
Scenario 2 – COMPANY X raises €30 million at the same €100m valuation. Assuming founders and management are strong and the market opportunity is there, more money means faster growth. But faster growth doesn’t just mean a bigger company when it is sold. It also means a higher multiple (of revenues, or profits, whichever is more applicable). It’s the combination of larger size and higher multiple that drives a significantly greater sale price. Raising €30 the founders own 5% less when money comes in, but earn almost €40m when it is sold versus €26m in Scenario 1.
So if dilution is far down the list of value drivers, what really matters? The multiple achieved on a larger company size absolutely dwarfs dilution in importance. It is this, and perhaps only this, assumption that should focus the mind of every founder lucky enough to be able to realise Scenario 2.
As promised, attached a simple excel worksheet you can play around with the assumptions yourself, to look at the trade-offs.
Dilution v Value Increase
Posted by Victor Basta @MaExits
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