Tell me more ×
Answers OnStartups is a question and answer site for entrepreneurs looking to start or run a new business. It's 100% free, no registration required.
up vote 1 down vote favorite

As far as I understand, when the next round happens, the startup emits new shares that are sold to new investors under newly negotiated valuation.

Does this lead to the previous investor's shares dilution, as they are not able to participate in the round with the new valuation?

Or do the next investors buy out the angel's share with cash?

Or are there some other shareholder agreement statements or schemes that prevent the dilution? If yes, what are the most plain words that can describe them?

I understand that every case is unique and an angel should consult with an attorney. I am interested in how it generally happens in places where the angel and venture investing system is the most developed, such as Silicon Valley. Sort of best practice.

share|improve this question
I think I got the correct answer to my question as I formulated it - 'it gets diluted'. I will accept one of the answers, but would like to wait for some more comments on 'how angels that fund new Facebooks and Googles (very high failure risk) stay interested in funding companies' – fedd Jan 7 '12 at 18:56
fedd, welcome to the site! Your follow-up question - "how angels that fund new Facebooks and Googles stay interested in funding companies" - is completely unrelated to the question you posed in this post. This site works best when you only ask one question per post. I recommend starting a new thread for your follow-up question. This will also help the question get more attention, which should result in better quality answers for you. – Zuly Gonzalez♦ Jan 11 '12 at 14:59

3 Answers

up vote 1 down vote accepted

Angels invest in a company HOPING they will be diluted.

If their shares are diluted, it means the business is growing. If new investors, such as VC firms come in, then the angels percentage of the shares is smaller, but the valuation of the company increases so the angel's shares are worth more each.

It is not such good news for angels if there are no new investors in the business. It often means that the business isn't progressing as hoped and this usually means the angel will lose all the money she has invested.

Early investors generally cannot avoid dilution.

Also, angels are not generally interested in being bought out unless they no longer believe in the business. Of course, this sends a bad message to the new investor and most founders will do their utmost to avoid that.

A successful investment for an angel is when they buy into the company in an early round, the business raises further capital and is finally accquired or floated in 5 to 7 years. This is the kind of scenario where an angel stands to make a lot of money even if their shareholding is a small percentage by the time the business is sold.

share|improve this answer
Thanks! I am trying to imagine a growth of the capitalization of a startup. If we are talking about the really risky, disruptive, highly innovative investments that are normal for the Valley investors (as far as I want to believe) - then 9 of 10 startups should fail (and this what people say really happens in VC business). The successfull startup should show a growth that covers 9 losses; if capitalization growth is connected with dilution, this growth should be even more incredibly high! Or are angels really risk averse and don't let 9 of their 10 sompanies fail? I need the Valley experience – fedd Jan 7 '12 at 18:46
You pretty much have it. Angels have similar failure/success rates to VCs as far as I understand. – Susan Jones Jan 8 '12 at 10:10
up vote 1 down vote

Does this lead to the previous investor's shares dilution, as they are not able to participate in the round with the new valuation?

NOONE says they can not participate in the new round, but it would still dilute them 8reduce their percetnage of the old already paid shares).

Or are there some other shareholder agreement statements or schemes that prevent the dilution? If yes, what are the most plain words that can describe them?

Reality check: you can not have your cake and eat it. There are X shares. Either you issue new shares, or someone old sells his (but then the moeny is not the companies but the old owners). If you issue new shares, you will dilute. If you do not dilute - you expect the investor to be so utterly totally stupid to give you the money witout taking a piece of the cake? You can not avoid dilution mathematically unless someone gives up what he already has.

The best you can say is that the old investor CAN buy new shares to the same valuation as the new investors. Then he can keep his percentage by putting in additional money.

share|improve this answer
thanks, I knew that, including that if the shares are bought from the old owners, "the money is not the companies but the old owners". I am sorry but I wanted to know how it happens in practice: how angels stay interested in funding companies, if their shares will be diluted. Because I assume they can't pay for shares the same price as the richer VCs, I thought there should be provisions to make the next round investors buy angel's shares for the new price, or block the deal. I wanted to know if I was right or wrong – fedd Jan 6 '12 at 19:00
up vote 1 down vote

All but the smallest VCs will reserve extra money for future rounds for this company when they make the A-round investment. Usually the series A terms gives the series A investors the right to buy shares in future rounds, and if things are going well, that's exactly what the money they reserved will be used for. This reduces their dilution in subsequent rounds.

Seed funds and Angels aren't expected to participate in future rounds. They do get more diluted.

As far as participants in earlier rounds getting bought out by those in later rounds, I haven't seen it as part of the finance package. I have seen shares change hands in private deals between investors and/or founders. I have also heard of rounds where founders can get some cash out, which makes a lot of sense in the case where you have paper millionaire founders who can't afford a peanut butter sandwich because there hasn't been an exit. The cash is meant to keep them from being too antsy about getting an exit.

share|improve this answer
thank you, i'd like to accept your interesting answer too, but can't choose multiple answers! and even have no karma to upvote :( – fedd Jan 10 '12 at 9:15

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.