Dilution: the real meaning of Funding Success

Dilution

A principal goal in the life of a scalable startup company is getting external equity funding. The closing of a funding round is cause for celebration. However, founders are often left with a somewhat bitter-sweet taste when they realize what just happened.

Funding success equals dilution.

This sense of “loss” is compounded by the realization that you can no longer have it “your way” (at least not entirely). You may now find yourself answering to a Board of Directors not yourself. That utter freedom of action and willingness to do whatever it takes to make “you” a success may be tempered by the realization that someone else will have a say in your life and benefit from the sweat of your brow.

OK, now get over it. Unless your “baby” was simply a lifestyle company, your goal was to get funding and grow.

Dilution and guidance is the price you pay for that growth.

Beyond that, there are several other reasons you should be truly happy, not just relieved, that you made it to the next step.

  • First, you just got “richer.”
    The value of your, admittedly smaller stake, just increased. Unless you just had a “down round” (in which case you have way bigger problems), your equity value increased. Your post-money valuation is likely much greater than the pre-money valuation. You have a smaller share, but that stake is much more valuable (at least on paper).
  • Second, you have likely gained some support.
    Someone else now wants you to succeed. If they got a Board seat, they are likely prepared to give you help and mentorship. You don’t know everything. Your investors understand your strengths and weaknesses from the Due Diligence process. They gave you a capital infusion and will mentor you because they want a return on their investment. That guidance can be invaluable…if you receive it with the right attitude.

All of this said, you need to prepare for this outcome just as much as you did in putting the investment package together in the first place.

You do not want to close the funding round, walk into your office and say, “How does this work now?”

  • Plan for milestones and metrics.
    You should already have these in place, but they are likely going to be more defined and strict. Expect this and try to anticipate the requirements. Understanding what specific progress they will want to monitor not only makes the transition easier, it will also make you a stronger candidate for funding in the first place.
  • Figure out what help and expertise you really need.
    Seek that mentorship from your investors (and other sources). Again, understanding your weaknesses and being willing to accept those who can provide it will likewise make your company more attractive to investors.
  • Modify and Adapt.
    You will already have defined your financial needs, but the investors may make “adjustments.” Work fast to integrate these new criteria into your execution strategy. Don’t waste time trying to “modify” this part of the deal after the fact. Your intransigence to live up to the agreement can undermine your investors’ confidence in your management team. This is the potential death knell for future funding.

Finally, celebrate! In an entrepreneurial ecosystem that is witnessing a contraction in funding, you made the cut. However, don’t spend too much time doing so, the next round of funding will be even tougher to get. You (and your new team) have some hard work ahead.

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Dave Clark

Dave Clark taught Strategy at West Point and is a co-founder of FundingSage, which provides valuable information, tools and resources to entrepreneurs seeking to start, grow and fund a business.