# Hidden dilution
- URL: https://www.petrikajander.com/hidden-dilution/
- Author: Petri Kajander
- Date: 2020-05-27
- Language: en
- Audio: https://anchor.fm/s/1018a6478/podcast/play/98857260/https%3A%2F%2Fd3ctxlq1ktw2nl.cloudfront.net%2Fstaging%2F2025-1-22%2F395326683-22050-1-8bae71bbffedb982.mp3
- Video: https://www.youtube.com/watch?v=ewD5hvyr8mk

The previous [post](/continuous-fundraising/) raised some discussion and questions so let’s continue on the funding topic.

By continuous fundraising, I meant not to take more investor money nor dilute your company more than intended. The hidden dilution can happen easily with convertible notes that start to pile up on each other and have different terms.

If you’re between rounds and need a quick fix till you get to your funding metrics and the actual round capabilities ready the bridge-funding convertible may leave your valuation (and conversion amounts) to the actual round.

This sounds convenient and it kicks the can a bit further. No need to figure out the valuation right now. The upside is that you may dilute yourself less because you can increase the value of the company with the bridge round resources.

There are a few downsides. What if you need to do a down round instead of having locked the valuation in the convertible? This could have happened earlier this year before Coronavirus, and now you are facing difficulties to keep the pre-corona valuation.

Another creeping consequence is that you’ve already used some of the next round’s cash. If you plan to make a 2m round but you have already convertibles (with their valuation dependent on the next round valuation with (or without) some discount) to the amount of 1m.

When you’re in the actual round your cash intake is only 1m and you have a significant portion of your conversion happening below the actual round valuation.

This leads to another consequence that how are you going to do the things you planned to do with the actual round funding since you’re now short (and assuming that you were still coping with other stuff like getting ready for the round because stuff happens or coronavirus) of fresh cash that is needed to get to the next level?

You may find yourself explaining and convincing the lead investor in the round why they should do the round nevertheless. The bargain deal might be just that for them. You end up diluting more than intended or spending more time chasing new investors and less time building the company.

[Video](https://www.youtube.com/watch?v=eGrrRtcXFOg)

## Transcript (https://www.youtube.com/watch?v=ewD5hvyr8mk, YouTube's automatic captions)

[0:02] Dilution the previous post raised some discussion and questions so let's continue on the funding topic by continuous fundraising I meant not to take more investor money nor dilute your company more than intended the hidden dilution can happen easily with convertible notes that start to pile up on each other and have different terms if you're between rounds and need a quick fix till you get to your funding metrics and the actual round capabilities ready the bridge funding convertible may leave your valuation and conversion amounts to the actual round this sounds convenient and it kicks the can a bit further no need to figure out the valuation right now the upside is that you may dilute yourself less because you can increase the value of the company with the bridge round resources there are a few downsides what if you need to do a Down Round instead of having locked the valuation in the convertible this could have happened earlier this year before.

[1:04] Corona virus and now you are facing difficulties to keep the pre- corona valuation another creeping consequence is that you've already used some of the next rounds cash if you plan to make a 2 m round but you have already convertibles with their valuation dependent on the next round valuation with or without some discount to the amount of 1 M when you're in the ual round your cash intake is only 1 meter and you have a significant portion of your conversion happening below the actual round valuation this leads to another consequence that how are you going to do the things you plan to do with the actual round funding since you're now short and assuming that you were still coping with other stuff like getting ready for the round because stuff happens or Corona virus or fresh cash that is needed to get to the next level you may find yourself explaining and convincing the lead investor in the round why they should do the round nevertheless the bargain deal might be just that for them you end up diluting.

[2:08] More than intended or spending more time chasing new investors and less time building the company.

## Transcript (https://www.youtube.com/watch?v=eGrrRtcXFOg)

[0:01] This fundraising tip is about M&Ms. Well, not really, but it's like popping those candies one after another or piling up papers on your desk called convertible notes and they are stacking up and you don't really know how many there are, or what's actually the cap table situation at the moment. Who are your shareholders? Who is owning what and how much? Because you haven't organized them yet. You haven't converted them yet, but you are building your company. You're getting the money in. You're moving, you are doing the things which are building the future. But the organizing part is a bit unclear. And what can happen? Like after a while popping all those candies, you realise that, okay, there's nothing left.

[0:51] This is something which can happen also when you doing convertible notes, for example and saying that you're giving a discount from the next round of finance. Let's say that you want to take 2 million in, but you already have taken half a million with convertible notes, maybe giving a bit of discount as well. For the first one, you gave -20% from the next round of funding, another one got -15% and the third one got -10%. So you have set in already the rules of the game, but you haven't set in the valuation for the company, because that's dependent on the next round of financing. So what happens when you actually come to the point where you need to do the next round of finance?

[1:44] You already have taken some of that money in, and you have used that money most likely. So you don't have that money anymore. It's not actually the full amount what you have to consume for the next phase of your company. You have already eaten that M&M bit. Maybe you only have a half of the candy left, but do you need to still do a lot of things and you have given up equity from the company, which may not be so favourable in regards to the terms. For example, let's imagine that Corona hit earlier this year, and you were hoping that you could double your evaluation and when you were taking those convertibles in, but you didn't convert them yet.

[2:36] And now you need to do a down round. The valuation went down because of the situation in the market: fewer investors, more uncertainty. the rules of the game changed. And now you're in a situation where you actually have given more ownership to the investors than you originally intended. You may actually manage to get a bit smaller round of money in, and all these things are hidden dilution in a sense that you're not exactly on the top of the game, knowing how much you have given out, how much you have at the moment. I've seen situations where it's really complex actually to make those calculations because of the rules, which are dependent on other factors.

[3:33] Suddenly you are in a complex maze. And if you add in employee stock options and a few other things to the mix, then it's fun or really not that fun to calculate who has what, how much and how much you actually own the company. Keep this in mind when you were piling up those convertible notes on your desk. Make sure that you know where you are at any given point, if that's even possible, because there are some unknowns, like the next round of financing valuation, which you may not have set yet, or may not have negotiated yet. But this is just a tiny tip to keep in mind. So there are no surprises when you're clear that pile from your desk.

[4:24] Till next time!