Can you explain "on every subsequent round of funding, your percent ownership goes down" ? Maybe a naive question. But if you are given say 50% of a company, how can your percentage of ownership decrease if someone funds it ? What's the mechanism for this ?

Dilution:

https://startupxplore.com/en/blog/dilution-shares/

The fundamental mechanism is that new investment is met by issuing new shares. If you hold options on a constant number of shares, and the number of shares into which ownership is divided goes up, then your fractional share of ownership goes down.

Say you have 50% of the company and your cofounder has the other 50%. That's all the stock, right?

If you want to raise money you need to sell some stock. So the company creates new stock and sells that -- increasing the total number of shares. You don't get any of that new stock yourself, so your total ownership percentage goes down.

What you are saying is true, but at least in theory you don't lose any 'value', because the money raised makes the company worth more. It's like going from 50% of a $1m company to 25% of a $2m company.

Of course in real life things are much more complicated. And, if I was a cynic, I'd say they are purposely complicated in an effort to screw people over.

Two ways this happens are liquidation preference and "participation". In both cases (they work differently but mean similar downsides for employee stock), your stake's value becomes conditional on a best case scenario exit and investors in practice gain more ownership than the numbers immediately reveal.

If the company fails, all that means nothing. If the company goes big, it won't matter. But in the most likely exit case where the company sells for less than everyone was hoping, now you get into the interesting territory where the investors might make their 1.5x return before you see a cent.

It's not that founders don't understand this. It's that founders end up taking these conditions when they're low on negotiation leverage and choose between that and running out of funding, so it's an understandable decision. However, they also avoid talking about it unless forced to because it changes how you will value your stock, which changes how attractive your offer or current compensation is. As a rule I ask about it when I talk to startups about job offers.

through dilution "you'll pretty much be set to the original value" after each funding round is what the OP said.

they're purposely complicated, and recruiters and VCs will take advantage of people who don't know how to do the math or reason about the amount of value extraction they're capable of, telling folks "oh this stock could be worth 100x of what is now"

Further, options come from a pool of stock that has last priority for cashing out. Preferred stock holders will get all value first, meaning an exit for less than the issued stock value will leave options holders empty handed. Sorry if I mixed up any important words, I’ve been out of the game for a couple of years.

In real life.

The founders and angel shares do not delute and your percentage goes down each round.

If your lucky they are worth the same.

Founder and angel shares absolutely dilute with additional rounds of funding unless you have provisions that are very rare in term sheets and founder agreements.

Pro rata [1] is pretty standard [edit: at least in early stage startups], so investors typically have the option to maintain their level of ownership by putting money into the round. Everyone else gets diluted. I think in practice investors only get diluted if they actually want to. I'm not sure how often pro rata is extended to founders, but I would guess it's pretty common.

[1] https://techcrunch.com/2017/09/13/how-pro-rata-works-in-vent...

It is not common that founders get pro-rata rights.

There are a number of additional factors not modeled here that affect real world decision making. First, most option grants revert ownership to the company if not exercised within 90 days of leaving the company. If the company is doing well, it only makes sense to leave if you can exercise. But the problem with exercising is that there can be enormous AMT tax liability if the company is doing well and the valuation has gone up substantially. For early employees, the taxes can easily be 10-20x the exercise cost or more. But since the stock is illiquid, there is no market for selling some of the stock to cover this liability. If you front the taxes with your own money (or worse, a loan) you are now in a position of enormous risk. If the company falters or collapses, your downside is huge and you can be hundreds of thousands of dollars in debt.

Basically they create new stock to issue out, which increases the total number of stock in the company in turn diluting the percentage of stock you own

The other responses in this thread are correct, but I suspect may have still left you confused.

You are correct that 50% is always 50%, but employee stock options are typically given as a number of shares, not as a percentage of the total, which is what allows for dilution. At least, that's how I understand it.

Any number of shares at any given point is a percentage of the company, and any percentage is always a certain number of shares.

You won't stay at that percentage though, unless the founders agree to protect you from dilution. In that case, they'd compensate you with some of their own shares whenever you dilute to keep your percentage the same. It's not common for employees though.

The point is that dilution works by creating new shares out of thin air -- the total number of shares increases. Meanwhile, the total percent remains 100%, for obvious reasons.

Sure, but that doesn't change whether you're giving out a number of shares or a percentage, because both are the same, just expressed differently. There's no common theme where somebody says "here are 0.1% of the company" and implies anti-dilution. It's just easier to talk about percentages than shares, because it's easier to calculate if you know the total valuation. You'll dilute in both cases.

Stock dilution I assume

> Even if the company is doing well, at the next round of funding, you'll pretty much be reset to the original value if you're lucky.

Obviously depends on the situation and what valuation you got, but unless it's a down round, your percentage will be reduced, but that reduced amount will be worth more (on paper). Sure, you might no longer have 1% of a company valued $1m, you'll now have 0.5% of a company valued $5m.

Except that it almost never actually goes that way. Instead what you get is .5% of a $5M company which has a $3M preference for the latest investor, leaving you with .5% of $2M, or exactly the same thing. Except more complicated than that.

That would be uncommon in my experience. Investors won't get the difference between the current and the last valuation as a liquidation preference, they'll typically demand one as high as their investment. Understandably, they don't want to throw in a million, get 20% of the company only to have the company disband and receive 20% of the $1m back.

The $5m won't come from a $3m investment, though. They'll take 20% for $1m, leading to a $5m valuation. And I don't know anyone that would give them a $3m liquidation preference in that deal. If your cash-on-paper (that is: shares vs total valuation) share doesn't grow in a round, that's a good time to think about getting out. If they were valued at $5m and are seeking investments valuing the company at $2m, run.

Yes, investors aren't throwing money around like they maybe used to, but I don't believe there's reason to be overly pessimistic. If the company becomes successful, you'll make money if you've been on board early enough (that is: if you took on risk).

Why would investors go for that? In case of no investment, the company goes under, so you get 1% of $0. Therefore, you should be happy with pretty much any kind of dilution, new investors can easily force existing shareholders to get e.g. 0.1% of $5m.

That's why you don't speak to one investor only. Investors want to invest to make money and they compete against each other (if the company is interesting). Yes, if the situation is "please give us money or we're dead tomorrow", the negotiation position is going to be bad, but that would be because of mistakes made earlier (i.e. not talking to multiple investors, not talking to them early enough, not understanding when the money is going to run out etc).

Generally you're going to raise at a higher valuation, so the fact that your percent ownership goes down at a higher share price isn't a bad thing. It's when you raise at the same valuation or lower valuation where it can be painful.