This post will likely not make me popular and might offend some individuals. If the core beliefs about how business should be done are at stake, you can’t try to win the reputation contest. In the event that you know me a little you’ll probably agree that like everyone at Point Nine, I’m a fairly nice guy.
We’re trying hard to make capital raising a bit more human being, and we really imply it whenever we say that we desire to be good VCs. I’m pretty sure that virtually all if not absolutely all of the more than 200 founders we’ve worked with during the last ten years would verify this. I’m not stating this to brag or to say that we’re perfect (which we are not, of course). In the last year, we’ve seen, on several occasions, a behavior among later-stage VCs that we’ve seldom seen in the years before. Here’s what I’m talking about.
In the last 12 months or so it happened many times that later-stage VCs, within funding rounds, offered a “re-up” (i.e. new shares or options) to founders of portfolio companies. Using this method, they try to partly or completely offset the dilution (i.e. reduction of ownership percentage) experienced by the founders in the funding round. If you think “Great, if founders get more shares and are diluted less, that’s amazing!”, think about the effect that this maneuver is wearing the existing traders of the business (as well as on employees keeping options or stocks).
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If founders get a re-up, each and every share, option, or possession percentage that they get (certainly) needs to result from someone. Which someone will be the existing shareholders of the business. Oftentimes, the re-up shares are proposed to emerge from the pre-financing cap table, in which case it’s obvious who bears the dilution.
Sometimes it is proposed that the re-up shares are manufactured post-financing. The latter might make the maneuver appears fairer on the surface, as it seems as if the new investors joined the existing investors in paying the purchase price for the additional founder shares. But if you are doing the math, you’ll see that it doesn’t solve the crux of the issue. More on that in the example below.
A trader who suggests a founder re-up will that, of course, to make his/her offer more attractive to the founders in order to boost the chance of earning the offer. 120M pre-money and a creator re-up of 10% pre-financing (which equal a transfer of 3% of the post-financing collateral from the existing traders to the founders). As you can see, the founders are better off in the second scenario, regardless of a ca. 15% lower valuation. For those scenarios, I assumed that before the financing round, the founders and the prevailing traders own 60% and 40%, respectively, of the ongoing company.