Is it wise for the founders to hold onto their ownership?

Is it wise for the founders to hold onto their ownership?
Photo by krakenimages / Unsplash

The term “ownership” defines what percentage of the company belongs to the founder and what percentage to the shareholders. At the very beginning of the journey, it is natural for a startup to be wholly owned by its founder or founders. But in the future, it is advisable to make a decision and start attracting investors to shares. But at what point, at what stage, and to what limit – you ask. Let's understand these issues together.

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Source: Index Ventures (https://www.indexventures.com/rewardingtalent)

No one will argue that property rights play an important role for founders and investors, both individually and for successful mutual activities, coordinating decision-making, balancing interests.

By having a stake in their business, the owners are motivated to stay with the company. Investors will undoubtedly act in the interests of the company to increase its profitability and, as a result, the value of their shares.

When deciding to start attracting investors to the share, you must always take into account that they carefully analyze your activities and the company's compliance with the market in which it positions itself. They also evaluate your team, both the founding staff and the team of specialists engaged in the implementation of the main mission. The investor wants to be sure that this particular company is best prepared to enter the market and use wisely what this niche has to offer.

Not all startups make it to Series B. They fail at launch or are resold. And very often it happens because the team behind the creation of the startup could not stick together from the very beginning of this path. A close-knit team and openness to venture capital are beneficial for the profit and Series B achievement.

Seasoned venture capitalists also understand that they need to align their incentives with those of the founders to keep the founders' desire to stay with the company in check. This can be ensured by the correct allocation of capital in such a way, that the alternatives do not arouse interest and do not exceed the “expected value” of their capital in the company.

If, for example, the founder runs a very successful startup and has a 2% ownership stake with an annual salary of $ 150K at the time he raises a Series C round. The post-money valuation is $ 100 million. The current “Expected Value” of her equity is $ 2million. Let's say that this founder receives an offer from a company with a very good market position that invites them to join and receive an annual salary of $ 0.6 million. Or they may also want to establish a new startup, which may cost several times more in the future. And then their alternative income may be more than the “expected value” of his capital in the current company.

It is necessary to control the valuation of the company and raise it if you manage to attract significant amounts of investment. If left unchanged, there is a risk of excessive dilution of the number of founders by a large number of investors.

Also, remember to keep everything under control and don't forget about the right to under-dilute. After all, even if you manage to have a sufficient amount of capital with a high estimate, it is not a fact that it would be wise not to attract more investors. At times, the market situation can affect the fundraising strategy and provoke a sharp rise in a startup, even with a low valuation.

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Source: Craft — How Much Equity Do Founders Have When Their Company IPOs?

It is equally important to effectively manage attracted capital. This is a responsible task for the founders of the company, which must be dealt with.

So how can a founder or founding team optimize dilution?

You need to accustom yourself from the early stages, to gradually increase the amount of attracted capital as close as possible to the time of transition to the next stage, and attracting only the amount that is necessary to move on with the highest value. And at later stages, when you are ready to scale, do the opposite - when the cost is higher, raise as much as possible, and try to stay in the market and stay in the top positions.

Remember the stages of a startup.

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Source: David Skok, www.forentrepreneurs.com

We hope that the data and information we have shared in this article will help you formulate your opinion and strategy for raising capital and, as a result, strengthen your position in the market and your reputation among both co-founders and investors.