The funding structure is more complex than just dilution. A VC can invest in a way that it may look like you are holding 50% of the company, but you may get allocated a much lesser value. For instance, if the VC negotiates a 2X liquidation preference with a full participating feature with a cumulative dividend pay out of 8% per year (and barring dividends to be paid to the common stock holders), the common stock despite having a 50% position may in reality get less than 10% of the company's value at exit. They can also add warrants that currently wont dilute common but on exercise will (it is just a delay effect - makes the founder's stake larger than it actually is). All this mean your stake has been effectively diluted through a variety of means and not just direct dilution. We use random scenarios to prove what a founder will get in different negotiating situations. There are also pay-to-play clauses which also affects common stock value. If you have anti-dilution protections in there, the VCs will simply negotiate a stricter participating preferred stock. The only way to negotiate is to go in with a game theory based model and keep plugging in VC numbers in a Monte Carlo random simulation scenario to see if the founders have a decent RoI under a random exit scenario.

I strongly advise that founders consult with experts like us to see if VC terms are fair game. We can calculate this using prevailing peer volatility considerations. If you are returning a VC more than the average return a VC expects, you are really not negotiating very well. We have reviewed so many SPAs where dilution has been achieved through several creative terms. The VCs are good at this - they have analysts on their side. Founders need to get someone on their side as well.

We know of companies where the VCs had so many clauses that founders had to renegotiate their stakes when they found that in the middle of a company's development, they wont even get 1% of the return. We had to go in and create a new preferred security class for the founders instead of the usual common stock, just to keep the morale high.

Series A and Series B term sheet negotiations are critical to realize the RoI he founders want. Fortunately, today, we have decent models to do this.

Shiva

On Fri, Apr 16, 2010 at 8:16 PM, Anthony Zeoli <[address removed]> wrote:

I totally understand the value VC represents. I just think we've
gotten to this point where money trumps all else. That the investors
dollar is worth more than the talent. That's a really sad state of
affairs. The almighty dollar is so powerful, we are negating other
things in favor of it.

?I am the only person here so far that hasn't jumped on the bandwagon.
Call me a rebel, I guess. I just have a fundamental issue with telling
someone they are going to have 10% of something today, but if you work
really hard you'll end up with 2%.

In a billion dollar company, 2% isn't anything to sneeze at. But, my
point is--and help me understand this, because I'm not an expert--why
even offer something you know going in isn't realistic? Why wave the
paper and say you are going to have X in this company, but then you
realize you now have Y? Why can't you just say here is the founders
10% that never gets diluted, and the other 80% is for all the
shananigans that are going to take place in the future?

I understand that as you raise rounds you need to have flexibilty in
pricing the company, but why does dilution have to happen in the first
place?

I know the more experienced folks on this list will shake their heads
and wonder why I don't already know the answer to this question or
have a different opinion. I've only been involved in two situations:
one I sold my company outright after raising a bridge loan, and two, I
was a founding employee who's contract was negated at the Series A and
I lost all my protections (I thought I had a good attorney, but I
guess I didn't).

Given the circumstances, I will agree that the PM you want to hire
should follow the "rules." I just think that if you come into
something being promised the value of X today, then you should get X
and not Y down the road.

I know people are going to think I don't have my head on straight
after this one...heheh. I will admit I don't have the formal training
or experience in these matters, but i still have a right to an opinion
based on that limited knowledge and I'm learning. Not everyone has to
agree with the way things are done. I'm sure there are those who don't
follow this path. They may be few, but the have to exist, no?

On Friday, April 16, 2010, Todd Smith <[address removed]> wrote:
> First, thanks for all the answers to the question thus far. Many of the usual suspects have answered, and having been on this list for a while, I highly value these opinions. There's millions of dollars and years of experience talking, so what an incredible resource. Thanks again.
>
> I feel your pain, Anthony. One problem is that it's sometimes hard to create value and revenue out of the gate without the helping hand that funding can provide. To truly build something great, sometimes it takes time and often people can't hold on that long for any number of reasons (work ethic shouldn't be one or they don't deserve reward anyway).
>
> I've been part of building something great -- not a technology but a financial product with a technology angle. I got cut in half for a couple million in the company's coffers, and it didn't hurt one bit. Did being in single digits feel great? Not particularly. But did telling my wife (with child at the time) that we had funding for three plus years feel great? Most certainly. I say that even admitting that if we had waited four months longer, our valuation would have been at least 4X higher (a glowing WSJ write-up will do that for you sometimes).
>
> To your last point of contracts being?renegotiated, yes, I don't ever think that's fair if it means you are getting promised equity ripped away from you. But?dilution?is a matter apart from that, and like some people have said on this list, and offlist to me: in the right amount, an investment boosts the underlying value of shares. Sitting on 100% of something the world sees as worthless (no matter how great it is) means jack.
>
> See: Innocenzo Manzetti v. Alexander Graham Bell
> The latter was able to find the funds and support to make the world see. The former died in agony. A?dramatic?example for sure, but a good one nonetheless.
>
> Todd
>
> On Fri, Apr 16, 2010 at 12:17 PM, Anthony Zeoli <[address removed]> wrote:
> I think there is going to be a time where the qualified people start to turn down start-ups, because of this is the dirty little secret. Come and help me build my dream, but then get diluted when someone with money tells you your contribution wasn't worth what was originally negotiated. Cash helps propel the idea, but if you don't have good people developing that idea, then that cash is just being wasted.
>
> This is why we should be building companies that actually create value and revenue out of the gate, brick by brick, instead of depending on VC money too early on.
>
> I don't know how or if I will ever be able to fight against this model, but I'm going to try my best. The worst feeling in the world is when you negotiate a contract, then someone walks in your office and tells you its now meaningless and your forced to renegotiate, or the company may not get its funding. They ride it on your head and say, if you don't agree to it, then we're all screwed. Great for morale.
>
> Tony
>
>
>
> On Fri, Apr 16, 2010 at 11:45 AM, Jonathan <[address removed]> wrote:
>
>
> On 4/16/[masked]:25 AM, Todd Smith wrote:
>
>
> Where I need insight is here: none of the current team has an
> anti-dilution clause. We all have vesting acceleration clauses, but no
> dilution provisions. This is owing to other companies I've started (felt
> the joy/pain of getting tons of cash but being cut in half), and on the
> advice of very successful business people. They all say, "do not promise
> anti-dilution as it can hurt your position with future investments."
>
> We're trying to bring on a pretty talented project manager. He's
> demanding anti-dilution.
>
>
>
> Give this person a pass, unless he's willing to take essentially the same deal as the founders (i.e., no anti-dilution).
>
> As a founder, I wouldn't put in anti-dilution clauses for myself knowing that it'll prejudice future investment. I likely wouldn't do it for any employee, either.
>
> My $.02.
>
> jh
>
>
>
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