Minimizing Equity Dilution

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💥 Learning Venture Capital & Startup Concept Series (Part 3) ⬇️⬇️

Super helpful to all the current & future Entrepreneurs + Finance/ Startup Enthusiasts !! 😀

How to minimize equity dilution in your startup for a founder -

📌 1- Do not raise too much:

Understand that more is not always better. Issue shares only that much which is necessary for the startup.

📌 2- Use SAFE and convertible notes cautiously:

SAFE and convertible notes are a form of debt that converts into equity at a pre-agreed price.

These types of securities are very attractive for startups as access to funds is quicker.

Conversion from debt to shares sometimes leads to substantial dilution due to discount and valuation caps.

The founders should make sure to limit the discount rate to a 20% maximum and the valuation cap isn't too low.

📌 3- Limit the stock option pool:

Stock options give an investor the right to purchase shares (common or preferred stock) at a pre-agreed share price.

ESOP (Employee Share Ownership Plan) is the most common type of stock option.

ESOP is a pool of options a startup reserves to issue to its employees in the future.

Only existing investors get diluted as part of the ESOP creation (or increase of the existing ESOP) as it's created out of the pre-money valuation.

Therefore, to limit equity dilution, you will need to make the ESOP large enough to make sure all new hires get the ESOPs they deserve, yet not too much to get too diluted either.

📌 4- Avoid excessive preferred investors clauses:

Be very careful about the below 2 Term Sheet clauses -

- Anti-dilution rights

- Participating in preferred stock

📌 5- Forecast & Model different cap table scenarios:

Doing this will allow you to understand the worst-case scenarios that may happen if you agree to specific terms in the future.


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