Over the last couple of months I’ve spoken to a number of early-stage investors — both angels and VCs — who seem to be proud of having been able to take 25-30% of a startup’s equity in an early-stage funding round. In one case, an angel investor patted themselves on the back for “managing to convince the founder to give them a 41% stake.” I was reminded of that several times as I was in Oslo this week, speaking with a number of players across the startup ecosystem.
TL;DR: If you are reading the above and you wish that you, too, could command that level of ownership stakes in a startup, I’ve got some bad news for you: you are being short-sighted, and you are hindering the startup, the founders and your own chances of finding success.
Founding a startup is hard. That means investors should help, not set up a situation in which the founders of a startup are disincentivized and demoralized, and won’t be appropriately compensated for their hard work in the case of an exit. And that’s precisely what will happen if investors take too much of a startup, too early.
To explain why investors patting themselves on the back in early rounds are slipping a poison pill into the startups’ cap tables, let’s take a look at what would happen to a company that dilutes by 30% in every funding round.
Why ‘poison pill?’ Because diluting founders too much virtually guarantees that the company won’t give a significant return on investment; if it needs to raise additional funding further down the line, future investors will likely balk at how little ownership is left for the founders.