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​example​Pext, Inc. raises its first external round as a priced round, closing a $250K raise with a $1M pre-money valuation. (If you have been reading carefully, you would rightly object to a priced round for a raise of only $250K, and suggest a convertible note instead, but bear with us so we can illustrate the dilution!) If the pre-money is $1M, the post-money valuation in this case will be $1.25M (pre-money valuation plus amount raised), and the percentage of the company sold will be 20% ($250K/$1.25M). Let’s say that our savvy investors insist that their ownership should be calculated on a fully diluted basis.

FIGURE 3S: Summary cap table prior to any investments

Consolidating the cap table above (Figure 3) to aggregate founders and employees prior to investment:

Shares or OptionsIssued and OutstandingFully Diluted
Employee 1345,0003.33%3.00%
Issued and Outstanding10,345,000100.00%
Option Pool Available1,155,00010.04%
Total Fully Diluted11,500,000100.00%

Figure A1: Impact of Raising $250K on $1M Pre-Money Valuation, Fully Diluted Basis

Shares or OptionsIssued and OutstandingFully Diluted
Round 1 Investors2,875,00021.75%20.00%
Issued and Outstanding13,220,000100.00%
Option Pool1,155,0008.03%
Total Fully Diluted14,375,000100.00%

Let’s assume that $250K lasts a year (founders are taking minimal salary), and Pext has made great progress. They now have a fully functioning app in the Apple app store with 10K downloads and great early customer engagement numbers. They want to hire a full time app developer and a full time marketing person. Based on the customer engagement and their execution to date overall, they raise another $750K round of funding, and convince investors that they are worth $3M pre-money. Again, they will be selling another 20% of the company: (750K/(3M + 750K)) = 20%. This would be a typical scenario.

The post-money valuation after the first round was $1M + $250K = $1.25M. So this is a great progress in the valuation from one round to the next ($1.25M post to $3M pre-money), and is called an β€œup-round.”

Figure A2: Impact of Then Raising $750K on $3M Pre-Money Valuation, Fully Diluted Basis

Shares or OptionsIssued and OutstandingFully Diluted
Round 1 Investors2,875,00017.10%16.00%
Round 2 Investors3,593,75021.37%20.00%
Issued and Outstanding16,813,750100.00%
Option Pool1,155,0006.43%
Total Fully Diluted17,968,750100.00%

At this point, everything is going well and the founders own almost 56% of the stock on a fully diluted basis. The Round 1 investors have been diluted from their initial 20% down to 16% by the Round 2 investors.

Scenario B: Raising $500K

For comparison now, let’s look at scenario B, where the founders raise $500K instead of $250K on the same $1M pre-money valuation. Now they are giving up a third of the company in the first external round.

Figure B1: Impact of Raising $500K on a $1M Pre-Money Valuation, Fully Diluted Basis

Shares or OptionsIssued and OutstandingFully Diluted
Round 1 Investors5,749,13835.72%33.33%
Issued and Outstanding16,094,138100.00%
Option Pool1,155,0006.70%
Total Fully Diluted17,249,138100.00%
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