Dilution by Future Investors A company may require multiple rounds of financing before achieving an exit event, your payout. Each additional round of financing will reduce, or dilute, the Angel’s initial ownership position. Let’s start with a fairly common, early seed round of Angel investment, where Angels invest $500,000 at a pre-money valuation of $1.5 million for 25% of the company. They grow the company to generating revenue and reach their initial validation targets to achieve a 3X valuation multiple (from their post-money value of $2 million to the new pre-money value of $6 million). The company is now ready for an “average” Angel round of investment (pre-money value of $5.6 million). But to make the math work easier, we’ll follow a more aggressive VC-backed high-growth investment plan. Let’s assume VC-A invests $4 million for 40% of the company. If the Angels do not co-invest, they will be diluted down from 25% to 15% [here’s the equation: 25% x (1 – 0.40) = 15%]. When the company grows 3X to $3 million, it becomes eligible for a Series B financing. Again, the numbers work well if VC-B puts in $15 million for 33% of the company. This will dilute the Angels down from 15% to 10% [15% x (1 – 0.333) = 10%]. To prepare for going public, or in some cases, to provide a pre-liquidity event for founders and Angels, a company may raise a Series C round of financing. In this highly dilutive example, a VC invests $45 million for 33% of the company, further diluting the Angels to 6.67%.
And that’s if things go well.
Effect of Dilution by Future Investment Rounds
Scenario A
Scenario B
Scenario C Scenario D
Pre-Money Valuation
$1.5M $0.5M
$6M
$30M $90M
Angels Invest VC-A Invests VC-B Invests
$4M
$15M $45M $45M $135M
Post-Money Valuation
$2M
$10M
VC-A Owns VC-B Owns VC-C Owns Angels Own
40%
33%
33%
25% 15% 10% 6.7%
These future rounds, and their normal valuation ranges, will affect the company’s valuation during the Angel rounds, too. (This topic is discussed further in section 6.1.)
65 A Practical Guide to Angel Investing: How to Achieve Good Returns
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