Questions

Our investor is consulting as well funding us - How does the cap table work? Who dilutes? The new guy or the shareholders?

For example, in a friendly Angel round, if an Investor is investing equitv to 1% and also getting equity equivalent to 1% for consultancy work (CFO). If one happens before the other (there's a couple of others joining in same way too), what happens with dilution? a) The new guy dilutes one part against another as it's a second process in shareholding dilution and he's now in with the first part so proportionally dilutes too? (e.g. equity dilutes by a further x% as precedes consultancy agreement). b) Existing shareholders dilute total 2% bearing the cost of any dilution as this person(s) are expecting 1% for both aspects at this stage - as mentioned this is a friendly round, definitely want to be fair, but don't want to set an unnecessary bad precedent as will likely be future round(s) or even more likely due diligence against exit in next year or 2. Thanks!

2answers

Whenever shares (or options) are issued, the language is normally "fully-diluted shares"... and what that means is that you *authorize* the number of shares necessary for all potential [foreseeable] options to vest.

You'll need to stop talking "%" and start talking in actual share numbers. Let's say the company has 1,000,000 shares, divided half between two founders. Then let's say a decision is made to "sell" or "trade away" 20% of the company. To do that, the founders don't lose shares — you create new ones. So the original million becomes 80%, which means you'll need to authorize 250,000 new shares. You can then sell 25,000 to the CFO for cash, let them earn up to 25,000 more, and distribute the other 8% to new hires over the coming months.

If you do this 2% transaction all by itself, the math will be more annoying the next time you want to hire someone and grant stock options or whatever.

In all cases, if you authorize shares, or issue options, and then they fail to vest (i.e. the CFO changes his mind and fails to earn the 1%), those authorized shares simply don't get issued to him, and that benefits all other shareholders proportionally.

Does that make sense? It's only "8th grade algebra", but it can be rather confusing... even many founders, lawyers, and investors I know are still prone to getting tripped up here. Feel free to contact me directly for additional help if you like.


Answered 4 years ago

This is a legal question, I would like to have a look at the term sheet for the recommendation and advisory. It is not that simple to answer about the dilution of the equity. The agreement will show the way for equity dilution.


Answered 3 years ago

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