[compumike]

The "certainty of over-dilution" is an important technical point. It seems to be a consequence of the illiquidity and high friction of conventional priced equity rounds. But it may be possible to design a fundraising instrument that avoids this problem.

For example: company raises $10M Series A, issuing 2 million new shares at $5. Let's modify our special Series A docs to include a provision where the company has the option to repurchase up to 1 million of these shares at any time. The pre-agreed repurchase price is $5 per share plus some time-based interest rate and/or a fixed markup. (Hmm, this sounds a lot like convertible debt...)

If the company becomes profitable quickly they may exercise the option to repurchase the 1 million shares, reducing dilution while providing both an immediate return and ongoing upside to the investor.

If the company needs the longer runway, or simply decides it's more beneficial to use the cash to fund growth, they already have it and the investor has correspondingly higher ownership.

It's sort of like a vesting schedule for investors.

If such a structure was agreed to, the headline "Raise Less Money" would probably become "Burn Less Money". Right now, the mere raising of the money causes the dilution; in this alternative structure, it's the actual net consumption of the money that causes the dilution, because the alternative use of that cash can always be to reduce dilution.

[virgilp]

But why would an investor agree to that? It's more risk with less upside:

- if the company does well enough that its share price rises, it's only normal to buy back your share (why wouldn't it? they just raised better-valued round! Not buying you out is just leaving money on the table)

- if the company doesn't do well, there's no reason for it to pay the markup, they'll simply continue to burn the money.

So you risk the entire sum, but stand to gain significantly only from the non-repurchasable portion of it. I could _maybe_ see it working for a time-based interest rate (if the rate was high enough), but not for the fixed markup. Unless we're talking about a really hot startup that the investors are dying to buy into and would accept pretty much any terms.

[compumike]

Convertible debt agreements address this problem by making subsequent financing/acquisition/IPO trigger an immediate conversion to equity. (Similarly, in my alternative, it could simply disable the repurchase option.)

This lets you achieve high resolution financing based on the amount of cash you have in the bank immediately before the next financing/acquisition/IPO. If you raised $10M but only spent $6M before raising the next round, you may use the remaining $4M in the bank to perform the repurchase. But you can't use the new Series B money for the repurchase. If you consumed $9M then you only have $1M remaining for the repurchase and will eat more dilution.

Effectively, your dilution becomes a function of how capital efficient you've been. Investors may agree to it because it might encourage people to build profitable companies: it encourages companies toward capital efficiency as they search for product-market fit, while giving companies enough runway to weather hard times.

For founders, this means your net dilution is now a stronger function of how well you operate over time (and a weaker function of how well you fundraise). That may be a good optimization for the startup ecosystem.

I agree with you 100% that "you risk the entire sum" but limit the upside. There are more knobs but it may be possible to set them in a way that investors agree to. Imagine my 2M shares @ $5 Series A. Suppose 1M are repurchasable at $6 (a 20% markup) plus 10%/yr interest rate. At t=0-, the investor has $10M and the company has $0. At t=0+, the company has $10M in the bank and investor has 2M shares. At t=1yr, suppose the company has spent $2M getting launched ($8M remaining) and hits some great milestone (i.e. becomes profitable, raises a new round, or gets acquired), and it exercises the repurchase option. After repurchase, the company has 8-6.6 = $1.4M remaining in the bank, and the investor has $6.6M cash plus 1M shares. The investor's effective purchase price of their remaining 1M shares is $3.40/share, thanks to the $1.6M in profits from the repurchase discount and interest.