Forums: Discussions for entrepreneurs and small business.

Hi,

Our start-up is raising its first round of $1M for 25% of equity. The post-money valuation is therefore 4 million. One of the investors is demanding that the shares be non-dilutable. Problem!

Giving away 25% of non-dilutable chunk of the company will cause serious problems with regard to further fund raising. The company will have limited ability to raise additional funds. True or false? It also means that only the founder's shares will be sold in future rounds.

I am thinking that the dilutable and non-dilutable share scenarios are two extremes that are not fair to one party or the other (founder vs. investor) With dilutable stock, founder gets free shares with every consecutive round, in the non-dilutable share case, investors enjoy all the upside from up rounds and get additional shares.

I am thinking there has to be another way. How about prorated dilution? Is there such a thing? For example, if the investor owns 25% and the founder owns 75% and the next round's pre-money valuation is $10M, while the new capital infusion is $2M, the NEW investor will buy shares from the founder and the prior investors, on a pro rata ownership basis, i.e. 25% of shares from the prior investor, and 75% from the founder. Granted, these are not OLD shares they are buying, but the newly issued shares, which are first assigned to the founder and first investor on their pro rata basis.

Does this sound like a known scenario? I think this is actually the only fair scenario for all parties.

Second question, can this be structured with options or warrants to the first investor?

Thanks!