Raising Your Series A

Now let’s take a deeper dive into the mechanics of raising a subsequent round. By this point, seed investors have bought 20% of the company. Several employees have joined and were granted a total of say 7% leaving 3% remaining option pool.

Given we have covered SAFE conversion already, in this example we assume the seed round was a priced one to simplify the calculations and emphasize the points on option pool and prorate. But the effect is the same.

Our starting cap table now looks like the following:

Next, the founders agree with the Series A lead on an $8M investment at a $40M post money valuation. The new investor will buy enough new shares to own 20% of the cap table which translates to 714,286 shares (PPS is 32,000,000 / 2,857,142 = $11.2) and the investment would only dilute each shareholder by 20% (8/40). So founders ownership would go from 35% to 28% (0.8*35), etc. And the cap table would look as following:

Link to Captable

However, there are two problems with this cap table. First, the option pool has now been diluted down to 2.4%, barely enough for the number of new hires needed as part of this cash infusion. Additionally, the existing investors have also been diluted down to 16% but they often have pro-rata rights in the subsequent round. Addressing both problems will increase the dilution to the founders further.

Refreshing the option pool

Let’s start with the option pool. In order to create another 10% option pool, which is very common in a Series A, the company will need to reserve enough shares such that the option pool after getting diluted by the Series A investor will be 10%. In this case the number is 354,286 new shares.

Link to Captable

But in order to maintain the Series A investor’s target ownership of 20%, the number of Series A shares now have to go up from 714,286 shares to 791,837 (the dollar invested will be the same but the price per share will go down to $10.10), and the resulting cap table will end up with 1,146,123 new shares or a total dilution of 1,146,123/3,959,183 ~ 29%

Dealing with pro rata

Now if the seed investors also decides to maintain their 20% ownership, they will need to participate in the round. The company now must issue additional shares to seed investors, the series A investor and allocate more options in the option pool. To address all these needs, the company will end up issuing a total of 1,542,858 new shares resulting in a cap table with 4,400,400 shares. Seed and A investors will both end up at 20%. But the founders will get hit by a whopping 35% dilution (1,542,858/4,400,400)

It is not uncommon for founders to get hit with 25-30% total dilution in a Series A round. But fortunately there are strategies a founder can follow to limit the dilution

Suggested reading: Minimizing Founder Dilution