Hidden dilution

May 27, 2020
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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 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.