When one of three founders add a capital round alone, how should he be compensated? Note or Equity


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We have a startup with 3 co-founders each having 33.3% of the company. So far we have raised 100k internally and split it 3 ways. Now we wanted to raise another 100k round internally. If one founders adds the 100K (while the other 2 add nothing) how is it fair to be compensated (lets assume the internal valuation for the firm is $1 million).

A) Everyone gets diluted by 10% equally (30-30-30), and then the one founder bumps 10% (30-30-40)
B) A convertible note for 100K (with a industry standard interest rate, premium to series A investor and valuation cap)

What are the positive and negatives of each. Also, how would a convertible note effect the need for a future convertible note down the line? We intent to raise a $300-$500k in convertible note 3 months later through angel/seed investors. Would those investors demand better terms?

Thanks!

Equity Convertible Note Dilution

asked Aug 17 '12 at 00:18
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Calman5555
1 point

1 Answer


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Whether it's equity or debt is an issue to resolve among the founders. The basic issue is this: if the company decides to fold, does the investing founder get paid his $100K back first before any of the other founders see anything? If so, then it's debt. If not, then it's equity. I think most companies would do that deal as stock.

ASsuming you're doing a stock deal, then ignore the percentages -- pretend you each have 33 shares of stock, each worth $10K, and this guy wants to buy 10 more. Now, you have a total of 110 shares, with him having 43 of them. In other words, take the pre-money $1M valuation, divide by the number of shares outstanding to get a per-share value. Now, divide his $100K investment by the per-share value to figure out how much he gets. If you do the math, he should end up with 13/33rds of the company, or about 39.4%, with the others having 10/33rds, or about 30.3%.

That said, the deal really depends on everybody's leverage and on how well they play together -- if the company really needs the money, and he's the only guy willing to pony up, he might drive a harder deal.

answered Aug 17 '12 at 02:46
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Chris Fulmer
2,849 points
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Equity Convertible Note Dilution