Specifics will always drive a more accurate answer. Much depends on the valuation and other variables, which this question asks to put aside.
The general rule of thumb is:
For Series A, expect 25% to 50%on average.
For Series B, expect roughly 33%.
As you advance to the next funding round, you should realistically expect further dilution. Founders start with 100% ownership. Seed rounds – the earliest stage of funding, usually from family and angel investors – typically dilute founders ownership by an average of 15%.
By the time you reach the Series A stage, you need to be prepared for further dilution. Series A investors are usually funders who provide venture capital for emerging companies. Since their funding typically exceeds $2 million, their percentage of ownership can be as high as 50%.
If you get to the Series B round, expect a dramatically different mindset from earlier funders. Whereas Series A and seed investors believe in your vision and have bought into the prospects of your company, those in Series B want to see that you’ve successfully progressed and satisfied important milestones. They typically see about 33% ownership, which will dilute all previous ownership percentages.
You also need to reserve a percentage for the option pool – usually, about 10% to 15%.
Startup Funding Rounds – The Basics
(Note that for the purposes of this discussion, it will be assumed that a startup founder intends to legally structure their new venture as a corporation. Some limited liability companies and certain partnerships may undergo similar rounds of startup funding, but the concern related to issuance of shares at every stage is irrelevant to those enterprises that don’t issue shares as both a source of funding and means of ownership in a given venture.)
Startup funding has become an increasingly complex and an increasingly creative enterprise in recent years. Some organizations obtain 100% of their startup funds from crowdfunding, others source from more traditional venture capital firms, while others choose to explore emerging sources of fundraising, including issuance of electronic currency, benefitting from angel donors, and taking advantage of a host of hybrid entrepreneurial platforms. However, most startup founders are discovering that it’s not generally the best strategy to place all of one’s eggs into a single basket. Pulling from several different potential sources of startup funding is generally a better approach, partially because it’s difficult to secure all necessary funding from one source and partially because the risks associated with startup funding at this point in time mean that it’s often wise to cultivate a varied portfolio of low-risk, moderate-risk, and higher-risk funding sources. When both the operation in question and its investors are benefitting from a good mix of risk-sharing, the startup’s fundraising portfolio is going to look more welcoming to additional potential investors approached in each round of funding. As an added bonus, when a fundraising portfolio is reasonably varied and relatively stable as a result, internal talent, consultants, etc. are going to be more likely to “hop on board” as well.
It’s worth noting that the percentage of shares issued at each round of funding is not only influenced by a startup’s fundraising efforts and ultimate goals, it is also influenced by the fact that earlier rounds of funding are more risky than later rounds of funding are. There are solid reasons why roughly one-third of shares are saved for issuance during the “safest” round of fundraising and the earliest rounds may only see issuance of roughly 10% of shares total. When an enterprise’s fundraising efforts can speak for themselves, there is far less risk to anyone “signing on.” By contrast, the earliest fundraising rounds are significantly risky and shares issued here generally serve a different purpose than those issued at later stages of the game.
Pre-Seed and Seed
The primary reason why only 10% to 25% of shares are issued during pre-seed and seed funding rounds is that these rounds are foundational. At this stage of fundraising, shares are generally only issued to ensure that an operation is appealing enough to secure significant financing from external sources down the road and/or to ensure that critical sources of internal talent (consultants, startup “partners,” etc.) are attached to the project. This is not usually the time a startup founder should hand out shares left and right just to make a few bucks. On the contrary, shares should be very carefully guarded at this stage and only issued with great intention.
Obviously, startup founders begin the process of fundraising with 100% ownership in their enterprise. They must carefully weigh the consequences of diluting that ownership interest in every fundraising round. The cost-benefit analysis of diluting ownership interest during pre-seed and seed rounds usually comes down to “Will issuing shares to loved ones, associates, angel donors, venture capitalists, and/or internal employees RIGHT NOW make a huge difference toward getting me to the next level of my fundraising?” In essence, will diluting ownership interest so early in the fundraising process make your enterprise more attractive to other fundraising sources and/or talent you hope to recruit? If so, it may be worth the investment. If not, you may need to think twice or may need to simply issue fewer shares than you were originally contemplating to a less valuable shareholder (in this context, value is relative to next-level fundraising and potential for longer-term gains). Most of the time, startup founders see their ownership interest dilute by roughly 10-15% before Series A begins. However, this percentage must obviously remain somewhat fluid, given the influences in play and the ultimate goals of the startup founder in question.
As traditional models of startup financing have evolved, venture capital firms have become increasingly reluctant to “get in on the ground floor.” Too many startups have proven to be too risky to back at the earliest possible stages of financing, so most venture capital firms hang back and wait to invest in new enterprise until pre-seed and seed fundraising is complete. These more traditional sources of financing tend to “get in on the action” during Series A. At this point, a startup founder can expect approximately 25% to 50% of shares to be diluted, as a way to secure enough financing to allow a business or organization to become a viable, and possibly operational, enterprise.
If venture capital financing is being sought during Series A, their equity will generally be issued as preferred stock. By contrast, pre-seed and seed funding rounds tend to have equity issued as common stock and common stock options. This is another consideration that startup founders must weigh when moving forward through the fundraising process – “What kinds of shares will be issued at each point in time?” Both preferred and common stock dilute ownership. But each grants the shareholder different rights within the broader scheme of the company’s ownership. Preferred stock holders generally don’t have voting rights, but they have a greater claim to assets than common stock holders do. As a result, if startup founders are interested in raising capital but want to retain more control over internal company decision making, they may be more inclined to issue a significant amount of shares during Series A.
Not every startup needs to progress to a Series B fundraising round. It is possible for some enterprises to secure enough funding before this point that further dilution of ownership interest is unnecessary and could even harm the vision of the startup founder. However, if this round of fundraising is necessary and appropriate, founders can expect approximately 33% of shares to be issued at this point in time. At this point, additional venture capital funding and other institutional investor interest can take fundraising to new levels. If a startup is looking to expand right away, wants to tap international markets, or otherwise can’t achieve its mission effectively without even more fundraising, Series B is where the rubber meets the road. Startup founders should expect that Series B investors will want to carefully evaluate that various milestones have already been met before they invest in the company’s vision. This round of funding is far less based on “faith and dedication” to a vision than it is on concrete results.
Startup Fundraising Assistance Is Available
If you’re looking to fund a startup, please consider scheduling a consultation with the team at LawTrades today. We have assisted more than 1,000 startups with navigating every aspect of the launch process, from fundraising to incorporation to recruiting the right talent to serve a new company’s vision. When launching a startup, it’s important to have a solid financial, legal, and practical foundation in place, because launching a business rarely goes “according to plan.” Benefitting from the guidance of an experienced team will help to ensure that your new venture can successfully navigate the choppy and often unpredictable waters of beginning a new venture in earnest. We look forward to learning about your vision and advising you of your options.