Posted by Early Growth
January 10, 2013 | 5-minute read (870 words)
Of utmost concern to many entrepreneurs is how to retain maximum equity in their startups. Rightly so. It’s a constant balancing act: growing your company without losing control of it. Whether you’re funded, seeking funding, or still bootstrapping, here are some of the best strategies for avoiding dilution and maintaining maximum equity:
1. Milestone raises. In my opinion, the best strategy for retaining maximum equity in your startup is to do milestone raises. Simply put, this means that you need to understand exactly how much money you need to get to the next milestone and raise that much (plus just a little extra so that you have some wiggle room, in case it takes you longer than expected to reach your milestone). Doing so will prevent unnecessary dilution and it allows you to get the highest possible value for each round.
Keep in mind that your milestones may not be set at regular intervals (in fact, they probably won’t be) so it’s a mistake to merely raise money for a given time period. Really think through what you want to accomplish, how long it will take you to achieve this goal, and how much you will need to hit your milestone. Milestone raises are built on the foundation of a solid business plan and financial forecast. There’s no way around that.
For help with your financial strategy, contact Early Growth Financial Services.
2. Bootstrap. Don’t be too quick to raise money. The sooner you sell equity, the more it will cost you, in the long run in loss of leverage as well as dilution. Instead do everything you can to get your company off the ground on limited funds. Carefully control your cash burn and be very smart about not spending money foolishly on non-essential expenses. In order to control your cash burn, you need to have a clear understanding of your burn rate (that is, exactly how much capital you need every month to keep your business running). See my previous article How to Reduce Your Startup Business Burn Rate for more information about calculating and managing your burn rate.
3. Improve your startup traction. While you’re bootstrapping, you should be building traction. This is where you will gain your equity advantage. This includes such things as building your founder team, developing a prototype, and establishing the beginnings of your customer base. Once you get to the negotiating table, the range of the terms is already set, to some degree. The more traction your startup has, the better your pre-negotiation position will be.
4. Outsource non-essential functions. If you outsource instead of hiring, you’ll save significant amounts on staffing costs, which will allow you to hold off on receiving funding for a longer period of time. Also, every employee you take on will have some share of your equity—which is fair and good—but, in the beginning, rushing to hire can dilute your equity before you’ve had a chance to really think it through. Read my previous post, Bootstrapping Your Startup: 3 Staffing Tips, for advice on outsourcing.
5. Consider alternative funding sources. Don’t be too quick to jump to VC funding. If you’ve bootstrapped as much as you can and are in need of additional funds, you should consider your sources before going for it. Institutional investors such as VCs usually offer less attractive terms and higher dilution. Instead you may be better off considering other funding sources, including friends and family, angel funding, SBA loans, etc. For a comparison of angel investors and VC, check out my previous post Angel Investors vs Venture Capitalists: Targeting Funding Sources.
6. Raise big rounds only when you’re ready. More isn’t better when it comes to funding. This is sometimes hard to swallow when you have money signs in your eyes, but it’s a fact. While it’s tempting to raise as much as you can, until you are ready to scale and really need large sums, less really is better.
7. Negotiate terms. The negotiating table is sort of the last resort for maintaining equity. If you’ve already bootstrapped, mapped out your milestones, and built traction, you’re ready for funding. Read my previous post on 9 Ways to Negotiate Your Best VC Terms for detailed strategies. Once you’re at the table, keep in mind your equity goals as well as the other terms that you deem essential. Don’t blindly accept standard terms; these are just your starting point. Before executing the term sheet, you want to be sure to negotiate to your best deal terms.
How do you plan to maintain equity in your company? Tell us about it in comments below or contact Early Growth Financial Services for help with your financial strategy.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He's a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.