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Stake dilution a dilemma for start-ups raising funds
Having started your start-up and having proved that the product or service has generated revenues and acceptability in market is definitely a proud moment for entrepreneurs. Once having reached this where in your own confidence gets proved which gives you the clarity of looking in for investors and also it gives you the confidence yes I can handle funds and increase the revenues to next level before exiting the investor.
Having reached this point where in your product or service withstood the test of time and acceptability in market, then next is scalability which will increase your revenues know to scale you need to go at full speed for which you need fuel to be loaded, that’s where you need a business plan to understand if I take money to put in 10 litres of fuel with 40kmph speed what distance can I covered is explained.
So having prepared your business plan, presentation, executive summary & teaser the hunt for investor begins. Don’t expect the day you start the next day you will have the investor it usually takes 3 months of 12 weeks before you start identifying shortlisted investors with whom you start final discussions.
Once on this part the next golden dollar question is what stake should I give to investor, for this first basic is your company should be Pvt ltd as it’s much easier for investor to invest in pvt ltd than proprietorship.
The basic parameter for arrival of equity dilatation is done by DCF method ( Discounted Cash Flow) so the business plan cash flow statement will give you the total of positive cash flows on which you do DCF method to arrive at valuation and the total amount you are requiring divided by the valuation today will give you the clarity of equity dilution percentage.
Once on arriving the percentage also be prepared to justify and defend, don’t be in hurry of giving extra stakes for 1st round of funding as you will be requiring further funds in 2nd rounds and so on, so negotiate well and ensure that you don’t dilute too much in the 1st round.
Don’t get to fancy numbers by saying 12X is my valuation and for this I will give only 10% to investor which will also ensure that investor walk out as there is no set rule on which valuation is considered across globe it’s just a value which is arrived keeping in mind market conditions and scalability aspect of your product or service
Usually 1st round would be somewhere between 20 to 25% dilution should be fine. Also don’t give fancy sales forecast numbers and don’t have statement which says we are targeting 0.01% of market.