The Compounding Effect of Cash Efficiency on Founder Ownership

Many founders don’t concern themselves with cash burn because in their view, if they run out of cash, so long as they’re growing they can just raise more money in this environment.  We understand the view because VC are awash in cash ($13bln was raised by venture firms in Q1, which is the most since 2000), but there’s a more compelling reason to keep burn down and be cash efficient: limiting founder dilution.

 

It’s obvious that the less money you raise, the less dilution founders have to withstand, but what many founders don’t realize is that the relationship is not linear.  In other words, being cash efficient has a compounding effect on limiting founder dilution: in a simple analysis we did, raising 50% as much money and being cash efficient resulted in 121% as much ownership for founders (not just 100% which is what a linear relationship would imply).  While it doesn’t sound like much, in our example the compounding effect results in the founder taking home $52mm as opposed to just $43mm, so that additional 21% is pretty meaningful.  The numbers are below:

 

  Founder Investor       Percent of   Revenue Proceeds to 
Raise More/Burn Cash Ownership Ownership Pre-Money Raise Post-Money Biz Sold Revenue Multiple Founder
Day 1 100% 0% $0 $0 $0 --- $0 --- ---
Angel Round 3 months later 83% 17% $1,000,000 $200,000 $1,200,000 17% $0 --- $833,333
Seed Round 12 months later 69% 31% $3,000,000 $600,000 $3,600,000 17% $0 --- $2,083,333
Series A 18 months later 44% 56% $8,000,000 $4,500,000 $12,500,000 36% $1,333,333 6.0x $3,555,556
Series B 18 months later 29% 71% $20,000,000 $11,000,000 $31,000,000 35% $5,000,000 4.0x $5,734,767
Series C 12 months later 19% 81% $40,000,000 $20,000,000 $60,000,000 33% $10,000,000 4.0x $7,646,356
Series D 12 months later 14% 86% $90,000,000 $30,000,000 $120,000,000 25% $22,500,000 4.0x $12,903,226
EXIT 12 months later 14% 86% $150,000,000 --- --- 100% $37,500,000 4.0x $21,505,376

 

 

In the table above, we show a company going from the angel round to exit in 7.25 years.  At each round, we show the pre-money as well as the amount raised.  Note that the amount raised is based off estimates of where the market is today and the pre-money’s are based on a percent of the business sold.  The final column which is proceeds to the founder shows what the ownership stake is worth after all the growth and offsetting dilution.  In the table above, our founder raises $66.3mm to build a company that exits with $150mm in revenue.  The dilution over time results in an ownership stake of 14% worth $21.5mm.

 

In the next table, we show what it looks like if the founder was cash efficient and raised half as much capital.  Given the compounding effect of capital efficiency on dilution, in this example the founder raises 50% as much cash ($33.1mm) but instead of owning 100% more equity (28%, or 14% x 2), the founder owns 35% thanks to the compounding effect of cash efficiency. The value of the founder’s stake at exit is therefore $52mm or 21% more than it would be if there was no compounding (with no compounding, the 28% stake would be worth $43mm).  The table is below and the following link will take you to an Excel version of the tables so you can see the math.

https://www.dropbox.com/s/l5is9zadr0hhcdf/Founder%20Economics.xlsx?dl=0

 

  Founder Investor       Percent of   Revenue Proceeds to 
Raise Less/Use Cash Efficiently Ownership Ownership Pre-Money Raise Post-Money Biz Sold Revenue Multiple Founder
Day 1 100% 0% $0 $0 $0 --- $0 --- ---
Angel Round 3 months later 91% 9% $1,000,000 $100,000 $1,100,000 9% $0 --- $909,091
Seed Round 12 months later 83% 17% $3,000,000 $300,000 $3,300,000 9% $0 --- $2,479,339
Series A 18 months later 65% 35% $8,000,000 $2,250,000 $10,250,000 22% $1,333,333 6.0x $5,160,250
Series B 18 months later 51% 49% $20,000,000 $5,500,000 $25,500,000 22% $5,000,000 4.0x $10,118,137
Series C 12 months later 40% 60% $40,000,000 $10,000,000 $50,000,000 20% $10,000,000 4.0x $16,189,019
Series D 12 months later 35% 65% $90,000,000 $15,000,000 $105,000,000 14% $22,500,000 4.0x $31,221,680
EXIT 12 months later 35% 65% $150,000,000 --- --- 100% $37,500,000 4.0x $52,036,134

     

In summary, cash efficiency and keeping burn down isn’t just good for investors, it’s good for founders as the compounding effect of cash efficiency results in significantly lower founder dilution.     

Blossom Street Ventures. All Rights Reserved.
Web Site Design by Idealgrowth