Founders Need to Understand Share Dilution
Convertible securities, including the convertible note and the SAFE (Simple Agreement for Future Equity) are popular startup funding mechanisms that entrepreneurs use particularly for angel funding, but they do result in equity dilution that is important for startup founders to understand.
Click Here to get the StartupSOS Dilution Spreadsheet for Notes and SAFEs now!
The Multiple-Convertible-Securities Challenge
Startups often raise funding with multiple notes and SAFEs each of which can have different terms. That makes understanding the potential dilution a challenge. To keep the dilution implication in mind, you need a spreadsheet that can forecast dilution for complicated, multiple-securities scenarios.
How will your Priced Round Affect your Dilution?
Dilution of both founders and convertible securities investors is also affected by how those securities are converted into stock when a priced round triggers that conversion. There are multiple ways to convert shares – some of which favor Founders and others favor investors. Founders need to be aware of the range of dilution options (and their implications) to be ready to negotiate the best possible approach for founders.
Investors Also Need to Understand Dilution
Both the convertible securities investors, and the investors that invest in a priced round also need to understand the dilution impact they will experience from different approaches to the conversion of the convertible securities into stock. So they too need a spreadsheet tool for analyzing different approaches.
The StartupSOS Dilution Spreadsheet for Notes and SAFEs
The StartupSOS Notes and SAFEs spreadsheet can help both Founders and Investors forecast the dilution impact of convertible securities so everyone is better equipped to negotiate a fair deal. Spreadsheet features include:
- Analyze up to 10 Convertible Notes and/or pre-money SAFEs, combined with up to 10 post-money SAFEs
- Each Note or SAFE can have its own discount rate and valuation cap (pre-value cap or post-value cap for the pre-money SAFE and the post-money SAFE respectively)
- Each Note or SAFE can have a pro rata right to retain ownership percentage in the priced round that converts the Note or SAFE to stock
- You specify the cap table that exists prior to the convertible securities, including:
- Founder shares
- Allocated stock options that are committed
- Allocated stock options that are not committed
- You specify the terms of the priced round that converts the Notes and SAFEs to stock, including:
- Pre-money valuation
- Amount to be invested
- Amount of stock the investors require to be allocated to an uncommitted stock option pool
- The spreadsheet analyzes two scenarios for conversion of the Notes and SAFEs to stock:
- Scenario 1 (Founder Friendly scenario): the stock price is determined by dividing the pre-money valuation by the totally diluted number of shares. The latter is determined adding the founders stock plus the committed option pool plus the required option pool. Notes and SAFEs are converted based on that price, which means the founders, the SAFE investors and the priced-round investors are all diluted.
- Scenario 2 (favors the Priced Round investors): this scenario requires that at the end of the investment, after all convertible securities have converted, the priced round investors ownership percent is fixed at the priced round investment amount divided by the pre-money valuation, and the percent of the fully diluted stock being required by the priced round investors is fixed, at the end of the round, to that percent, without being diluted by the convertible securities. This effectively pushes all the dilution of the convertible securities onto the Founders. This is the scenario used in the examples in Y Combinator’s Quick Start Guide to the Post-Money SAFE.
Y Combinator Example
The spreadsheet as downloaded is pre-set with the example from Y-Combinator’s Quick Start Guide to the pre-money SAFE – specifically the example on page 23: “Example 2: combination of pre-money and post-money safes “.
Disclaimer
Although we believe the StartupSOS Dilution Spreadsheet for Notes and SAFEs works correctly, we cannot warranty that it is free of defects. We will provide updates if computational errors are discovered.
Cost
We’ve provided prior downloads of dilution spreadsheets at no cost. There were enough hours involved in developing this StartupSOS Dilution Spreadsheet for Notes and SAFEs that we are charging a small fee for this download. A small amount of revenue will help cover the expenses of the StartupSOS website and Youtube channel – so we appreciate your support! Check this Youtube video for a description of how to use the spreadsheet, or to understand how to develop your own spreadsheet.