Aug 1 2008 by Brad

Is Dilution Considered When Talking About Equity Ranges?

Q: When we talk about the equity percentage numbers for those directors and other early participants, are these numbers based on the total number of shares prior to a funding event or does the base share number include those allocated for investors as well? As the shares for future investors are hard to predict, I assumed that the percentage numbers we talk about here are before any dilutions, is that right?

A: (Brad) The answer is "it depends."  When we have written about equity and compensation in previous posts, we’ve tried to provide some context for the stage of the company.  When we’ve done this, you should assume that this does not include future dilution from other rounds of investment.

However, there are no absolute guidelines.  For example, when you bring on an outside board director, whether it is at the Series A or the Series D, the stock option grant is usually in the 0.25% to 1.0% range.  While this is a wide range (see – there are no real rules) it gets more complex when a director has been with the company for a while and taken dilution from subsequent financings.  For example, assume a director joins at the Series A and gets a grant for 1% vesting over four years.  Three years later, the company has raised $30m and the directors grant now represents 0.3% of the company.  In some cases, the director would get an additional option grant to increase his ownership percentage (say – back up to 0.5%); in others he wouldn’t.  This is a function of the board, the investors, the entrepreneurs – all based on their view and assessment of the director’s contribution.

The same is true for employees.  Most employees will take the same dilution the founders take with subsequent financings.  This is relatively easy to deal with in the success case because the dilution is less significant and the value of the equity continues to increase.  However, in cases where the dilution is significant (e.g. a down round financing) employees need an "option refresh" – this is usually negotiated in the context of one of the financings.  In addition, as employees start to reach the point where their equity is fully vested (as they’ve been at the company for four or five years) there is often a refresh option grant.

There’s no simple answer.  And – any numbers we put on this blog are merely guidelines.  You mileage will vary dramatically with the situation.