The dups Founders’ FAQ is a compilation of the most common questions founders ask us about their startup, their fundraising or their relationship with investors. In this 1st question, we tackle dilution and how you can handle the dilution effect when you let an investor in.
As a founder, I was heavily diluted in the fundraising process. How can I increase my participation in the future? At what cost?
Capital raising means dilution. A new partnership is being set up with a new balance and a new shareholder structure. Some founders come out of it with frustration and a desire to see their participation increase again. What are the usual mechanisms for a founder to increase his or her participation in the future?
A frequently used mechanism consists in granting the founder options on shares held by other shareholders of the company or by the company itself (“stock option”). These stock options consist of a mechanism that grants the holder the right to purchase during a period or at a specific time a certain number of shares at a price fixed in advance (“exercise price”). The seller agrees to sell the shares at the exercise price when the holder exercises the right.
When the founder exercises his option, he will acquire the shares held by his co-shareholder or the company under the conditions set out in the contract.
To ensure that these options are of interest to the founder, the exercise price will often be lower than the actual value of the share at the time the option is exercised. The price often corresponds to the price at which funds are raised. If the founder exercises his option, it is because he considers the exercise price to be lower than the actual value. As far as the investor is concerned, he will sell a part of his shares without gaining any added-value, but it is a positive signal: if the founder acts in this way, it means that the company has gained value since the fund raising.
Sometimes these stock options can only be exercised if certain objectives set out in the business plan are reached. The founder will only be able to exercise his options when the objectives are achieved (e.g. EBITDA above a predetermined amount).
The subscription right is a mechanism enabling its holder to subscribe for new shares in the company in the event of a capital increase or a new capital contribution at a price determined in advance.
When subscription rights are exercised, new shares will be created by the company and attributed exclusively to the holders of the rights. The other shareholders will not sell shares but will be diluted as a result of the exercise of the subscription rights.
The subscription right pursues the same objectives as stock options, but unlike the latter, the subscription right relates to shares to be created.
You have a question about dilution or other topics? Let’s have a chat, we’d be happy to help!