Non-Dilution Rights are Wrong

I hate non-dilution rights and if you are an entrepreneur you should, too.

I’m not talking about price-based anti-dilution protection that is typical in an angel or VC round. What I’m referring to is a right given to a particular stockholder so that such stockholder’s equity in the company is not diluted by any future issuance of stock — regardless of the price.

Investors will say this “protects” their investment from issuances of equity that do not benefit the startup. But the fact that the startup’s founders are being diluted by such an issuance should provide enough protection.

Unfortunately, for some investors having the founding team sit “side by side” with them is not enough protection. My advice to those investors requesting non-dilution is: if you don’t trust the founding team from issuing stock in the hopes of increasing the startup’s value — don’t invest in the startup.

My advice to entrepreneurs is, if you have an investor asking for non-dilution, it likely means that the investor doesn’t think you’re good enough to run the company. The investor is likely in love with your startup’s idea, but not in love with you.

Tags: non-dilution, startup

6 Responses to “Non-Dilution Rights are Wrong”

  1. William March 1, 2011 at 12:01 pm #

    Spot on advice. It is such a temptation for startups to take on money even if it severely compromises their ability to run the company and more importantly, their ability to raise money in the future, because the next round of investors 1) going to look at their investment as less appealing; and 2) are going to want anti-dilution themselves. This can wreak havoc on share value down the road.

  2. John R. Sedivy March 2, 2011 at 7:42 am #

    It could be just a sign of the times but it seems as if everyone is becoming increasingly risk adverse. Some entrepreneurs will not even begin building their business until funding is secured in an attempt to make their startup mimic a corporate job from day one.

    On the other hand investors are attempting to position themselves for “guaranteed” returns, thereby removing the “venture” out of venture capital.

    • Jason Coombs November 3, 2012 at 2:07 pm #

      You mean “risk averse” not “risk adverse” — averse, as in “having an aversion to” or “having an active feeling of repugnance or distaste” not adverse, as in “adversary” or “acting against or in a contrary direction : hostile; opposed to one’s interests, :an adverse verdict: :heard testimony adverse to their position:; especially unfavorable :adverse criticism:; causing harm, harmful :adverse drug effects:”

      A particular risk can be adverse to a person’s interests, but a person can only be averse to risk a person cannot be risk’s enemy.

  3. Dave Gillespie March 3, 2011 at 4:29 pm #

    Thanks for posting.

    I completely agree. I’ve had to deal with this a couple of times when founders have negotiated the deal prior to getting me involved. The parties have discussed anti-dilution protection but aren’t on the same page as to what that means. At the very least, if you can’t back the investor off the non-dilution rights, you have to carve out the same exceptions usually accompanying price-based anti-dilution protection and limit the rights to only the first X number of dollars raised.

  4. Andrew Medal April 11, 2011 at 9:49 pm #

    Ryan, your insight is always much appreciated.

    What would you typically propose if an investor or equity partner of any kind, is asking for the provision?

    I know it’s a case by case basis, but how are some ways to get around this?

    Thanks,

    Andrew Medal

Trackbacks/Pingbacks

  1. Kryptonite Angel Round Terms | Social Matchbox - August 23, 2011

    [...] investor wants non-dilution rights because they are either really greedy or they don’t trust you to issue additional equity. The angel investor’s best protection against “wasted dilution” is the fact that the founders [...]

Leave a Reply