When I speak to most founders and investors about financings, we focus on valuation. And when we think of valuation, the other side of the coin is dilution. For any fixed invested amount, the higher the valuation, the lower the dilution. Investors and founders can get fixated on this tradeoff of valuation vs. dilution.
A better way to think about this tradeoff is ownership vs. value add. Obviously valuation and ownership have their own relationship – they’re basically the same thing or two sides of the same coing (for any fixed investment, the higher the valuation, the lower the ownership). But if you shift the framework slightly and view the exchange or tradeoff as “ownership” vs. “value add”, then that can dramatically shift the conversation between the founder and future investors. Instead of focusing on the end result, (i.e., valuation/dilution), it’s better to ask questions like, “for X% of the company, what is the investor going to do to justify that ownership?” It makes sense because you would never give a future employee 1-2% of a company (let alone 10%!) without knowing specifically what that employee will do and how she will materially add value to the company’s trajectory in the future.
So the question I encourage founders to ask is “For X% of the company, what value will you bring to the company?” And “value add” is a Rorschach test – it means different things to different companies and a topic for another post (sometimes the best “value add” is not doing a thing!, i.e., first, do no harm). And good investors welcome this conversation too. Instead of arguing about valuation as if you’re buying a house, you’re talking about the tradeoff and exchange that really matters.
I’m a personal investor in a denim company in Wales called Hiut Denim. I love their jeans, their story, and the people involved, behind and around the company. When the founder, David Hieatt sends an investor update, he refers to his investors as “owners” and not “investors” (“Dear Fellow Owners,”). Maybe it’s a Welsh thing, but I think this difference in language crisply captures the essence of what I’m trying to say above.