Equity Stake – How Much Are You Really Giving Up?

The Investment Amount (or “Raise Amount”) is the total capital the investors are committing to your company in a particular funding round. This is the money that will fuel your startup’s growth, allowing you to hire, develop products, and expand operations.

The Equity Stake refers to the percentage of ownership the investor will receive in your company in exchange for their investment. This is directly linked to your company’s valuation.

  • Pre-Money Valuation: This is the agreed-upon value of your company before the new investment.
  • Post-Money Valuation: This is the value of your company after the new investment.
Post-Money Valuation = Pre-Money Valuation + Investment Amount

The Equity Stake an investor receives is calculated based on the investment amount and the post-money valuation. For example, if your pre-money valuation is $16 million and an investor puts in $4 million, your post-money valuation becomes $20 million. The investor would then receive a 20% equity stake ($4 million / $20 million).

Why It Matters

This clause is foundational because it dictates how much capital you have to operate and, crucially, how much of your company you are giving away.

  • For Founders: It determines the dilution of your ownership. While raising capital is essential for growth, excessive dilution in early rounds can significantly reduce your ownership and control in the long run. It also impacts how much capital you have to achieve your next major milestone (your “runway”- the time period for which your company can go on for before exhausting its cash).
  • For Investors: It defines their ownership percentage and, consequently, their potential return on investment. It also influences their level of influence and control over the company.

Common Variations

The investment amount and resulting equity stake can vary based on several factors:

  • Stage of the Startup:
    • Early Stages (Seed/Angel): Valuations are often lower, and investors might take a larger percentage (e.g., 10-25% per round) for a smaller investment amount due to higher risk. Sometimes, in very early stages, convertible notes or SAFEs (Simple Agreements for Future Equity) are used, where the valuation is deferred to a later priced round.
    • Later Stages (Series A, B, etc.): As your company matures and proves its traction, valuations increase, and investors typically take a smaller percentage for a much larger investment.
  • Negotiating Valuation:
    • Founders often aim for a higher pre-money valuation to minimize dilution. However, an unrealistically high valuation can set a difficult precedent for future funding rounds (a “down round” can trigger anti-dilution provisions, further diluting founders).
    • Investors will assess your company based on market opportunity, team, traction, and competitive landscape to determine a fair valuation.
  • Employee Option Pool: The size of the employee stock option pool (shares reserved for future employees) is often factored into the pre-money valuation. A larger option pool, while good for attracting talent, can dilute existing shareholders, including founders, if it comes out of the pre-money capitalization.
  • What can be potentially unfair:
    • “Non-dilution” clauses: Some investors might push for a “non-dilution” clause, which guarantees their ownership percentage remains constant regardless of future funding rounds. This should be avoided as it would severely dilute founders and other shareholders in subsequent rounds. Do not confuse this with “anti-dilution” clauses (which protect against down rounds and are more common).
    • Excessive Equity for Minimal Investment: If the investment amount is small but demands a disproportionately large equity stake, it could be a red flag. This might indicate the investor is not valuing your company fairly or is seeking to gain too much control early on.
  • What can push the founder back:
    • Insufficient Runway: If the investment amount isn’t enough to reach your next significant milestone, you’ll be back to fundraising sooner than desired, leading to more dilution.
    • Investor Control vs. Founder Control: While not strictly part of “Investment Amount & Equity Stake,” these figures heavily influence board composition and voting rights. Ensure the proposed deal doesn’t strip you of control over your company’s strategic direction.

Evolv’s Recommendations

  • Do Your Homework on Valuation: Research comparable companies at similar stages and industries to understand typical valuation ranges. Don’t just accept the first offer.
  • Focus Beyond Valuation: While valuation is important, don’t obsess over it to the exclusion of other critical terms. Sometimes, a slightly lower valuation with more favourable control provisions, liquidation preferences, or a better investor partner can be more beneficial in the long run.
  • Understand Dilution: Always calculate your ownership percentage before and after the investment. Be aware of how the employee option pool impacts your effective ownership.
  • Assess the Runway: Does the proposed investment amount provide enough capital to achieve your next 12-18 months of milestones? Raising too little too often leads to excessive dilution.
  • Negotiate Smart:
    • Be Prepared to Justify Your Valuation: Have clear metrics and a compelling growth story.
    • Prioritize: Identify what terms are deal-breakers for you and where you have flexibility. The “Rule of 3” (Always get at least 3 offers, compare 3 key elements in every offer, have 3 possible outcomes in your mind) suggests focusing your negotiation efforts on 2-3 key issues.
    • Create Competitive Tension: If possible, talk to multiple VCs. Having multiple interested parties strengthens your negotiating position.
    • Engage Legal Counsel: This is non-negotiable. Hire an attorney with expertise in venture capital financing. They can help you understand the nuances of each clause, identify red flags, and ensure your interests are protected. They are your backup, but you are leading the negotiation.
    • “People Before Terms”: As many experienced founders and investors advise, the most important “term” in a term sheet isn’t legal – it’s the quality of the investors you bring on board. Choose partners who align with your vision, provide strategic value beyond capital, and whom you trust.