How do you ensure you’re not over diluted by investors?

Posted by Michael Derin on 18-May-2015 12:12:00

I live and breathe technology businesses every single day.  A simple reality of such an ever changing and dynamic sector is I see both the FINANCIAL winners and losers. What if you’re a winner and build a successful technology business only to find your personal return is diluted and far from life changing. Does this make you a loser?

A recent example was a technology business that survived the dotcom bust and the GFC and ultimately took on a convertible note capital raising with a private equity group.  The exit was for well over $100 million! Pretty exciting after 15 years of blood sweat and tears. A project of a lifetime and the founder is a household name in the tech sector!

He himself netted less than $2m and then got taxed so netted after tax only $1.5m – hardly life changing.  While the PE firm netted $90m.  He is now looking at a new startup with limited personal funding capability but with learned experience.

So this is dilution, when your equity is diluted year after year from multiple capital raising and funding, such that the day you exit is not so exciting financially for yours truly. 

Why has this happened? 

Multiple reasons, the obvious one that comes to mind is doing a poor deal with investors, whereby you value the business too low for the capital raised.  However, it is a finely edged issue, because if you value the business too high then you may not get funding and not be able to realise the business potential. Speed to market is the key and this is hard without cash. 

I am actually seeing early seed funding deals with PE firms as quite reasonable for founders.  The real issues comes with subsequent funding.  Basically, many founders spend their investment funds poorly. They often go in circles with their tech idea, build some value never the less, raise more money, and then spend it poorly again. Eventually all this wasted spending, on the wrong people, lawyers, accountants, tech mentors, etc etc costs them in EQUITY DILUTION.  This I see as the biggest issue at the moment.  Why does this happen?

Often because their single objective is get to market very quickly and test the market with a wrong or deficient product. It is a contentious issue as many tech mentors say market testing is critical. That is true, but the clearer you are on your business model and the real focused product for your tech idea, the more efficiently you will spend the cash raised from investors, and ultimately, the more financially successful both you and your investor will be. 

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Topics: Startups