• Alex Petrin

How Does Venture Capital Dilution Work?

If you plan on raising seed capital or venture capital for your startup, several questions come up: How to create a cap table? How does venture capital dilution work? How to calculate dilution? How to calculate pre-money valuation? How to calculate post-money valuation? How do employee stock options work? How does preferred stock work? How to calculate investment return?

We made all of this very easy for you with our app which answers all of those questions with only a few inputs into your financial model.

Our app also helps startup entrepreneurs understand how much venture capital to raise. 

By following our simple step-by-step inputs, our model will automatically:

  • Show you how much venture capital to raise and when to raise venture capital

  • Create a cap table

  • Calculate your pre-money valuation

  • Calculate your post-money valuation

  • Calculate your price per share

  • Show you the impact of how venture capital dilution works

  • Show you how employee stock options work and how that dilutes your startup cap table

  • Show you how a liquidation preference impacts you

  • Create an investor return summary

  • Create a proceeds waterfall at various points of selling your business

  • Create your financial statements that are GAAP and IFRS compliant, and

  • Create all of the proper financial ratios

First, to input your founder's shares, employee stock options, seed capital, convertible note, Series A preferred venture capital, and Series B preferred venture capital inputs, just follow our very simple to follow inputs on the main menu. For example, here's how you input your founder's shares:

And here's how you input a seed investment:

After entering a few assumptions, including a Series A preferred venture capital investment, let's take a look at how the Startup Financial Model app automatically calculates everything else for you and answers the questions above:

1. How Much Venture Capital to Raise and When to Raise Venture Capital:

Once your business assumptions have been entered into the Startup Financial Model, navigate to the Verify the Plan Cash Levels where you can see both the normal scenario and alternate scenario cash levels at a quick glance:

While you can also go to the Cash Flow Statement and review that as well, we designed the view above and put it on the Input Assumptions menu to help you quickly understand the cash picture. For example, in the example above, more capital needs to be raised prior to launching, or the expenses need to be delayed until the seed capital round is raised in the 3rd month. In addition, the Seed Capital raised in the 3rd month is barely sufficient to last until the Series A preferred venture capital is raised in February of the second year as the cash levels drop to an uncomfortable low of only 12,313. This view clearly shows startup entrepreneurs how much venture capital to raise and when to raise venture capital. Or, alternatively, as the report indicates, you need to reduce or delay your plan and expenditure levels to bring the cash back up to a positive level.

2. Create a Cap Table, 3. Calculate Your Pre-Money Valuation, 4. Calculate Your Post-Money Valuation, 5. Calculate Your Price per Share, 6. Show You the Impact of How Venture Capital Dilution Works, and 7. Show You How Employee Stock Options Work and how that Dilutes Your Startup Cap Table:

When your assumptions (including venture capital investment assumptions) are entered, our app automatically creates a Cap Table for you that shows the impact of all of your equity assumptions entries and quickly answers the following questions: how does venture capital dilution work?, how to calculate dilution?, how to calculate pre-money valuation?, how to calculate post-money valuation?, how do employee stock options work? Please see our explanation video below where we walk through and explain the Cap Table in detail, including how it effortlessly answers all of these questions:

Our Cap Table report in our app does the following for you: 1) calculates your pre-money valuation, 2) calculates your post-money valuation, 3) calculates your price per share, 4) shows you the impact of how venture capital dilution works, and 5) shows you how employee stock options work and how that dilutes your startup cap table. For example, in this screen shot of the Cap Table, we've circled the the pre money and post money valuations of both the Seed investment and the Series A preferred venture capital investment rounds:

You can also see the Options and Warrants issued and the fully-diluted % column that shows the impact. Again, the video above walks through our Cap Table report in detail to explain all parts. For a simple explanation of how to manually calculate pre-money valuation and post-money valuation, see this post.

8. Show You How a Liquidation Preference Impacts You, 9. Create an Investor Return Summary, and 10. Create a Proceeds Waterfall at Various Points of Selling Your Business:

Here's an example screen show of our Investor Return Summary report in our app where we've highlighted the liquidation preference that was automatically calculated for you and inserted into proceeds waterfall for the end of each year of your plan (see the video above for a more detailed explanation):

11. Create Your Financial Statements that are GAAP and IFRS Compliant, and 12. Create All of the Proper Financial Ratios:

Our model also automatically calculates all of the appropriate financial statements such as the Income Statement, Balance Sheet, and Cash Flow Statement, along with all of the financial ratios in full accrual accounting formats that are rendered in both IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles) as shown in the video above. Here's an example screen shot of the Balance Sheet showing how the Seed Capital investment and a Venture Capital investment are automatically placed on the Balance Sheet for you:

For related posts on raising venture capital, please see the following:

Avoid These Six Novice Mistakes When Pitching Venture Capital Investors

Sharing Reports with Investors

Seed Capital and Venture Capital Assumptions

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