complicated concepts

What's the Deal With Dilution?

One of the biggest questions we get from new investors is the math behind dilution.

  • How diluted will my shares become?
  • Is there anything I can do to avoid it?

Turns out, these probably aren’t the right questions to ask.

Here’s our take on dilution and what metrics we think you should focus on instead.

Dilution and Ownership %

Before we can understand dilution, we gotta understand the concept of ownership.

Let’s pretend Eric invests $100k into my startup at a $1m valuation.

If we think of my company like a pie, Eric now has 10% of the pie, leaving me with 90%.

But his 10% ownership will dilute as I raise more money in future rounds.

I may raise $500k at a $5 million valuation in the next round, or $1 million at a $10 million valuation in the round after that.

I might also bring in key employees and strategic advisors who will also get a % of the pie.

Eric’s ownership could shrink from 10% to less than 3% depending on how much I raise.

While this drop may look scary or disproportionately small, angel investors should not be scared of dilution.

The pie has grown so significantly that a small % of a huge pie is still a LOT of value.

Note: Generally speaking, previous investors’ ownership goes down by ~33% as their portfolio companies raise their series B and beyond.

This is not a rule, but a pattern we’ve noticed in the industry and from investing in hundreds of companies ourselves.

Stop obsessing about ownership

We suggest new angel investors not obsess about ownership at all.

Why? Because obsessing about ownership may drive you to continually invest in a company that isn’t growing that fast, just to own a larger piece of the pie.

Instead, think in terms of multiples.

In Eric’s case, thinking in terms of multiples helps him focus more on the quality of the investment rather than the quantity.

So he’ll ask himself,

“If I give $1 to Tam, can he turn it into $100? Or $1,000?”

You'll be a more successful investor if you can find people who can 100x or 1000x your small investment than if you own 30% of a company that isn’t doing well.

There is advice from other investors who disagree with us. They advocate for ownership over multiples. Here are the dangers we see with that logic.

Dangers of optimizing for ownership

Think about it from the founder’s perspective.

Founders want to keep room on their cap table to bring in new investors that will give them different points of view.

There are very few angel investors who can make the case that they’re more valuable than other strategic investors.

But more often than not, angel investors try to elbow their way in to get as much ownership as possible.

This damages the relationship you’ve built with your founder and can harm their business by locking out helpful partners.

It also hurts your reputation.

Founders talk to other founders. They’ll share how you tried to bully your way into securing more ownership. And they won’t forget.

In a VC ecosystem that is strictly built on reputation, this can ruin many of your future investing opportunities.

So, what’s the takeaway here?

Look. Dilution is a reality, so expect it to happen.

But don't stress too much about it.

Focus instead on finding the right team… one that is solving a big problem and is obsessed with understanding their customers.

If the multiple is great, the pie will be big enough to gain a massive ROI.

One of Hustle Fund’s biggest wins is when Eric invested $20k in an early team that is now worth over $5m. This proves that you can produce big results without optimizing for ownership.

The best thing you can do as an angel investor is to get a small piece of a pie that you believe will grow exponentially.

That, and be a helpful, friendly investor.

Until next time,
Tam “1000x” Pham