How startup equity dilution works

Delivered November 8 @ 5:00pm ET

Table of Contents

• What’s been top of mind this week.

• Venture Alchemy - This Week’s Discussion

  • "You will get nowhere if you do not inspire people …

  • Selling versus Inspiring

  • The Difference Between Passion and Purpose

  • Tying it back to Venture Alchemy

• Venture Lesson - Startup equity dilution

Happy Friday everyone! My name is Gerry Hays, Founder of Doriot (pronounced: dor-ee-oh). At Doriot, we believe venture should be innovation-driven and permissionless.

More specifically, given the uncertainty artificial intelligence creates around how we spend our time and earn a living, it’s crucial to equip future generations with a venture mindset and provide platforms that allow them to activate their imagination, talent, and capital to bring new ideas and value to the world. Right now, only the wealthy and well-connected have this privilege.

Thus, in addition to launching a venture empowerment platform through Doriot, the weekly 'Democratize Venture' Insider is offered as an free tool for anyone ready to embrace the future and start down this path.

And I’ve elected to share net subscriber numbers on a weekly basis because, if you’re reading this, you are what’s considered an innovator on the innovation adoption curve. So, to you, in the words of Margaret Mead, “Never doubt that a small group of thoughtful, committed individuals can change the world. In fact, it's the only thing that ever has.”

And a quick shout out to Sonu! You have been such a great support, my friend! You will definitely be in the first public Venture Game! For everyone else, we’re still looking for guinea pigs 😆 

What’s been top of mind this week.

I am proud to be a part of this great experiment called Democracy. 🇺🇸 LinkedIN Post

Will we see Unicorns (startups valued at $1B+) with 5 people or less? 👩‍💻 Analysis / Technology that might power it.

What might the SEC look like in a Trump 2.0 administration? ⚖️ Article

To be an entrepreneur, are you ready to embrace the “misfit” in yourself? 🙃 Article

Why High NetWorth Individuals (HNWI) own venture assets. 💵 Doriot Post

Venture Alchemy - This Week’s Discussion

"You will get nowhere if you do not inspire people” - Georges Doriot

What It Means to Inspire

Webster’s defines inspiration as “the action or power of moving the intellect or emotions.”

Selling versus Inspiring

At our core, we don’t want to be sold a product or service; we want to be part of things larger than ourselves. We want to believe in an idea or vision that compels us to act, to adopt, or even to reshape our perspective. This desire is especially relevant today, in an environment cluttered with bait-filled posts and emails all clamoring for attention.

When people are truly inspired, they often adopt a new way of thinking or doing. Supporting an idea, product, or service then becomes an active, empowered choice rather than a passive transaction.

To me, inspiration is a reflection of authenticity and a clear sense of purpose. When a person speaks from a place of genuine belief, it resonates, and people naturally want to be a part of that purpose. It’s an energy that’s contagious and self-sustaining.

The Difference Between Passion and Purpose

There’s often a misconception that passion alone is enough to move a vision forward. Passion can spark strong emotions, but it doesn’t necessarily create an urgency to act. It’s purpose that transforms ambition into a mission, and it’s purpose that invites others to join you on that mission.

When a founder has truly found their purpose, however, their actions become “inspired” in the truest sense. They’re no longer driven solely by profit, market share, or valuations but by the impact they want to create. And in taking purposeful action, they naturally inspire others, creating a ripple effect that can transform teams, partnerships, and customers into advocates who believe just as strongly in the mission as they do. This is what General Doriot is referring to in his quote.

Tying it back to Venture Alchemy

So for those aspiring to lead: 1) align with your purpose, 2) create strategies to fulfill that purpose, 3) and execute on those strategies. Rinse and repeat. In time, after a period of sustained action, people and opportunities will begin to find you.

Venture Lesson - Startup equity dilution

An often misunderstood concept, particularly for first time founders, is how startup equity dilution works. So let’s jump into the math.

Suppose Brody, Quint, and Hooper start a marine-tech company. Brody will lead the company as CEO, Quint head of product, and Hooper head of technology. They agreed to distribute the initial equity (founder’s equity) as follows:

Of course, the smart approach here is to have each of the founders ‘vest’ their shares. This means they will earn their shares over a period of years as they actively contribute value to the company. If, for example, one of the three founders gets eaten by a shark, any unvested shares would remain in the company’s treasury to be potentially redistributed to future employees or investors.

(The worst case scenario for a startup is someone holding a large chunk of equity without contributing ongoing value or having made a capital investment.)

Now, let’s suppose they secure $1,000,000 from Orca Ventures in exchange for preferred equity convertible into 25% of the common shares, fully diluted. This arrangement means Orca has the right either to receive its original investment back (a return preference) or to exchange its preferred shares for common shares and sell those shares for a profit. And they only make this decision upon a liquidity event (i.e. IPO or Acquisition).

So, how many shares need to be created to account for Orca’s new equity claim? It’s straightforward:

(10,000,000 / (1 - .25)) - 10,000 = New Shares

= 3,333,333

10,000,000 is total shares on the cap table and .25 represents Orca’s ownership claim to total shares

And, $1,000,000 / 3,333,333 = $.30 (price per share paid by Orca)

So, based on this, Brody, for example, has been diluted from 40% to 30% ownership. However, the value of Brody’s equity is now $1,200,000 on paper (calculated as $4,000,000 * 0.3). So, while his ownership percentage has decreased by 25%, the value of his ownership has increased significantly. In an ideal situation, the process repeats itself (more dilution, higher stock price) until an exit. Everyone wins.

There’s also a caveat. In addition to Orca’s 25% claim on common shares, their preferred position entitles them to the first $1,000,000 in exit value before any distribution to common shareholders. This means that if the company is sold for only $1,000,000, Orca would receive 100% of the proceeds. This repayment priority further reduces the effective ownership value of the three founders. But this arrangement is fair, given that Orca is investing $1,000,000 to help build the company - it’s reasonable that they should be repaid before the founders can liquidate their shares

Hope this lesson was helpful!

Have a great weekend, everyone! Go IU Football!!! 🏈 

Sincerely, -gerry ([email protected])