Equity dilution for mobility early-stage companies. How much dilution is “normal”?

The overwhelming majority of start-ups are likely to fail without external capital. High-growth companies frequently rely on early-stage financial resources to sustain their growth until they attain profitability. Fundraising options are either dilutive (equity) or non-dilutive (grants, loans, etc.).

While there are exceptional cases where start-up companies manage to self-fund through bootstrapping, they remain the minority. Therefore, most companies need to incorporate new shareholders (investors) to their cap-tables in exchange of the capital received, and founders will have to manage equity dilution as a natural effect in the evolution of any start-up.

In the world of start-ups, understanding equity dilution is crucial for founders seeking funding to fuel the growth of their companies. With each funding round, founders must navigate the complex landscape of equity distribution and make informed decisions to ensure the success of their ventures.

This article explores the concept of equity dilution, specifically focusing on mobility early-stage companies. We aim to shed light on what is considered “normal” dilution levels and the implications it has on founders and investors.

Incorporation

When a new company is incorporated, founders receive 100% of the company’s shares. Every time there’s a funding round, investors and other shareholders will receive new shares. The number of shares investors will get — equity — depends on the amount investors decide to invest and the company’s valuation.

Founders need to make pivotal decisions to make sound fundraising decisions to propel the growth of their companies. Priced equity rounds, convertible notes, and SAFEs (Simple Agreements for Future Equity) are the most frequent agreements that can be made between founders and investors.

There are two main formulas to invest in early-stage companies:

1. Investing in a priced equity round: investors purchase shares in a start-up at a fixed price

2. Investing in convertible securities: the investment amount eventually “converts” into equity

Early-stage funding rounds: investment instruments

During the past years, the vast majority of early-stage funding occurred using priced equity rounds, where investors get direct exchange of money for preferred shares (equity) at an agreed-upon price.

Other than priced rounds, investors used convertible notes as an alternative investment instrument, which is a debt that converts into equity when some parameters (maturity, qualified financing round, etc.) are met.

These days, SAFEs are predominant in the EU start-up markets as they offer more flexibility in fundraising than convertible notes.

As ventures raise additional capital, founders will inevitably give up more shares and ownership. This will be reflected in the cap table, is a document that outlines the ownership details of all shareholders of your company, including the amount of shares they own and the assigned value of their stock. This information is crucial when calculating exit returns both for founders and investors.

It’s therefore paramount for founders to understand the long-term consequences of setting the right fundraising structure. While large funding rounds may seem advantageous, and are often praised, every single euro raised implies a dilution on the founders’ equity and, eventually, other shareholders who invested in prior rounds.

In other words, the larger the funding round, the more equity dilution founders will face. Besides, large funding rounds are not always beneficial for capital efficiency, and can potentially distract from the company’s core objectives.

How much equity dilution is normal per funding round?

Having invested in 80 ventures from pre-seed to Series A since 2020, EIT Urban Mobility has observed some dilution patterns in its equity portfolio companies:

1. Most of pre-seed and seed rounds aimed for a dilution of between 15% and 20% per round. This, in average, generated a runway of 14 months.

2. Series A+ rounds aimed for a dilution of 18% per round. This generated approximately a runway of 18–20 months.

Conclusions:

Exceeding the recommended dilution rate or conducting too many funding rounds can lead to excessive dilution, which may harm the company’s ability to secure capital and negatively impact its financing prospects.

Lack of funds is one of the primary reasons why a start-up fails to sustain its operations and eventually going bankrupt. That is precisely why it’s crucial for founders how to manage share dilution as an early-stage company, so as the runway generated in the funding round, or the amount of time it can continue operating before depleting its funds.

Ideally, founders should aim to maintain equity of 50% to 60% of their company after the completion of a Series A round. Even if the company and its founders show great potential, venture capitalists and other early-stage investors are likely to lose interest in investing if the cap table doesn’t meet their expectations.

Founders continually give up a portion of their equity to investors and employees over time. If founders retain close to 10% ownership when the company goes public (IPO) or get acquired, they would be in an exceptional position.

EIT Urban Mobility invests in European mobility ventures to help them scale sustainable, investing up to €500.000.

Do you want to know more about EIT Urban Mobility investments? Visit our company website and LinkedIn. You can also contact us at investments@eiturbanmobility.eu.

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This article was written by @Pablo Garrido, Investment Principal at EIT Urban Mobility.

About the author

Pablo Garrido — Investment Principal at EIT Urban Mobility — strives to make data-centric investment decisions in European mobility ventures that steer the transformation towards a sustainable urban mobility landscape.

Contact at: pablo.garrido@eiturbanmobility.eu