Diluted Founders

finance a la shmoop what are anti-dilution provisions okay people we [Man talking inside a beaded wall]

are inside of the beaded walls of start-upville.com and there's a

disagreement revolving around the vision that two parties see in their crystal [Person waves at crystal ball]

balls the founder this gal rose-colored glasses the visionary behind brain

planes her telepathically controlled flying car company her vision of the

future flying cars everywhere in just two years well she thinks that her first

round of investment capital is a bargain at $1 a share and she is certain that

the next round of investing which she expects to happen in two years will be [Investment round 2 brain planes stock at 10 dollars a share]

at $10 a share so that's the vision of rose-colored glasses very fast uptake in

demand for telepathically controlled flying cars no big regulatory hurdles no

major accidents and no headaches but the vision of Manny milesonhistires is

very different he thinks that the dollar a share he's investing at is a gift a [Manny thinking of a gift]

gift to the company way too rich, way too expensive, a very high price to pay for a

stock with zero proven track record Manny believes the long term vision that

telepathically controlled flying cars are in fact the future Manny just

believes that it'll take longer for the masses to adopt this new way of doing

things and you know iron out the bugs ouch Manny thinks that rose will miss [Iron squishes a bug]

all of the financial projections she has made on her projected income statement

you know as part of her business plan and normally he'd just wait around until

the next round to then invest likely at a cheaper price he thinks but he knows

that if he doesn't invest now well he'll be iced out of the next round which he

thinks will be at 50 cents a share meaning half of the dollar he's putting

in so to protect his shareholders the people who gave Manny the money to invest

on their behalf in the first place his limited partners Manny gets an anti [Shareholders give Manny money]

dilution provision in his contract that is he invests at a dollar a share to buy a

third of the company a million shares got it a buck each

million shares...then time passes sure enough cars

do crash into trees, cars crash into each other, cars crash into buildings cars [Car crashes into building]

just crash okay and while texting and driving you have a very bad idea

and of course Rose is forced to do the next round of funding sheepishly at

fifty cents a share well if there were originally two million shares of common

stock that belonged to Rose as the founder and Manny bought a million of

them for a dollar with the company now raising 1.5 million dollars at 50 cents

a share while the company would have a total of 6 million shares outstanding

the original 3 million shares in the first round plus 3 million shares now at

50 cents each see we're doing the math of the dilution here for you it's scary

but Manny originally bought a third of the company for his million bucks for a

million shares, Manny still owns that million shares he bought at a buck each

only now his ownership stake has been massively diluted he owns a million out [Manny's shares highlighted]

of a total of six million shares outstanding or 1/6 of the company way

down from the one third he originally bought well his current stake is roughly

just 17 percent of the company so his anti-dilution provision kicks in and his

original million bucks gets essentially repriced to the 50 cents that the new

round was set for...so what actually happens here well basically he is issued

more shares to "true him up" unquote to owning a third of the company again [1/3 ownership circled]

why a third, because that's what his anti-dilution provision stipulated in

the contract he had bought a million shares owned one out of six million and

to be undiluted he needs to own 2 out of 6 million or said another way Rose is

forced to print more shares to give to him so that he now owns one-third of the

company which is what he originally signed out to own when he put in the

million bucks with this second round the company has 6 million shares out and if

another million is printed and given to him well then he'd own 2 million shares

but there would be 7 million shares now outstanding so depending on how brutally

the anti-dilution contractual language was written Rose might have to print [Paper printing]

even more shares to cover his anti-dilution clause

at the cost of her dilution and yeah note in all of this just how much Rose

has now been diluted from owning a hundred percent of the company the day

she started it while she now after just two rounds still owns her two million

shares that comprise all of the company at the beginning only now there are some

seven million shares outstanding and likely many many more to come as she

raises more and more capital so at this point she only owns two sevenths of the

company and of course none of this will matter if the flying car biz doesn't [Rose driving a flying car]

take off or maybe takes off a little too quickly if you know if you catch our

drift [Car floating into space]