Equity dilution: when and why should you give up equity?

When does equity dilution occur? 

Reminder of the principle of equity 

Equityrefers to external funds provided by partners or shareholders to finance a company.

In reality, it is a financial value that is also called equity or investment capital. If thecompany is liquidated, the shareholders receive this financial value. 

Equity is used to finance various projects during the company's existence in order to increase its operating potential.

Focus on the principle of dilution

Before anything else, it is imperative to understand the principle of dilution.

In concrete terms, dilution occurs when a founder asks for an investment in exchange for a share of his company's capital, in other words, he will share his capital and part of the control of his company. 

The capital increase carried out with an issue of new shares will generate this dilution. One can also speak of equity. This phenomenon is very common in equity fundraising operations. 

Dilutive financing

The most common dilutive financing solutions are:

• love money, 
• business angels 

venture capitalists. The entry of these recognized investors often allows an increase in the visibility and credibility of the financed company.

It also shows the general public that thecompany is on the road to a promising future or at least that there are already players who believe in its success. In addition, the investors can act as mentors and advise the partners with an outside view of the strategy. 

When should you give up equity? 

Although at first glance, financing yourself by opting for a fundraising or any other dilutive financing seems like an interesting strategy, one should not rush into it and forget the consequences. 

Here are 5 situations where it's best to forgo equity.

Neglecting shareholder choice

As you have understood, when diluting equity, new players must be taken into consideration. Therefore, after a dilution, you are no longer alone and you must also respect the needs of your shareholders.

Sharing your business with people who don't have the same vision can quickly turn into a nightmare. Ask yourself the right questions before you commit: Are they in line with your business strategy? Do they have the same ambitions? Will they impose constraints?

Don't lose sight of your identity. Theinvestment itself must respect your company and your values.

Have a disproportionate funding strategy

Receiving funds is the ultimate grail. But be careful not to bite off more than you can chew. It is important to define the amount you really need.

A large influx of money is not easy to manage. You may not have the capacity to use it all effectively, which could distract you from your primary strategy .

In short, if you try to gain too much, you could lose a lot. It is therefore necessary to study the financing needs of the company and to anticipate the management of the funds.

Do not consider the capitalization table

A capitalization table is a table that shows the number of shares and the percentage of ownership of all shareholders in a company. 

The mistake is not to consider this table. It is crucial in understanding your strategy and anticipating growth.

It is indeed possible to use this tool to model how different financing options can dilute existing shareholders' equity and earnings per share. It's up to you to imagine all the possible scenarios!

Do not try to limit dilution

Dilution is a fact but not an end in itself. You must not let your project melt into an uncontrollable dilution system. It is up to you to present your project in its best light and above all with strategy.

In concrete terms, it is essential to have a clear understanding of your business strategy and its growth potential. 

The objective? To present your company to shareholders in a way that minimizes dilution. 

Headlong pursuit of dilutive financing

Tax benefits, grants, loans, Merchant Cash Advance, crowdfunding or Revenue Based Financing are non-dilutive financing solutions that should also be considered!

Depending on the company, its financial situation, its business strategy and its objectives, different options can be considered. Its solutions allow you to forget the hassle of dilution.

Why and how to give up equity? 

The risk of capital dilution

The principle of dilution is obviously not without consequences. First of all, it is important to bear in mind that by distributing shares of capital, the founder's decision-making power is reduced. 

The issue of new shares will create new voting rights for the benefit of the new partners. The founder of thecompany must then take into account these votes in the decisions.

In addition, the dilution of capital leads to a reduction in the amount of earnings per share (EPS). The new shares created will grant new profit-sharing rights and the new shareholders will also receive dividends. 

Inevitably, the unit amount of dividends received before the transaction decreases for the founder.

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Limiting the effects of equity

Contrary to popular belief, it is possible to limit the effects of equity.

Indeed, it is possible to build a co-financing strategy calling on public funding. You can also prevent dilution by making a seed loan or applying for innovation grants. 

Mastering the tax system can also be a great help. Think in particular of the CIR and the JEI status. The key is to anticipate as much as possible!

However, it is not possible to eliminate these effects entirely. The last solution is to use non-dilutive financing methods such as Revenir Based Financing.

Revenue Based Financing to waive equity

Looking to grow your digital business without dilution? Karmen will finance your growth in key areas such as marketing and recruitment. 

The Karmen offer is a financing tool that adapts precisely to your needs by establishing an instant, fast, flexible and non-dilutive line of credit.

Karmen provides financing for growth through an instant, flexible and non-dilutive line of credit. 

This financing solution allows you to : 

• establish a simplified reimbursement schedule
• to retain control of the capital through non-dilution at 100%.
• get credit released within 48 hours

To be eligible, the funding request must: 

• be spread over a maximum of 12 months
• include an amount of up to 5 million euros
• be based on revenue growth

Revenue Based Financing is an innovative, non-dilutive financing solution that provides cash flow based on a company's future revenues.

Revenue Based Financing (RBF) funds are transmitted on a virtual card that makes it easy to take control of the cash flow. The process is digitalized and fast: in only 48 hours, a company can receive funds.

The consideration to be paid is not an interest rate, but a fixed percentage, usually around 3 to 6%, on the company's future revenues.

Finally, Revenue Based Financing can also be used to complement fundraising. It is a very interesting strategy to implement and allows to find a good balance between short and long term financing.

Conclusion Equity dilution is a phenomenon that must be considered in its entirety.

Many criteria must be taken into account in the case of a dilutive financing, which is why certain situations must prompt the abandonment of equity. One should not lose sight of the consequences of capital dilution, such as loss of power or lower earnings per share.

However, don't panic, it is possible to easily give up equity. Non-dilutive financing solutions exist and can be considered. The best example of such financing is Revenue Based Financing.