DEFINITION of 'Diluted Founders'

Diluted founders is a term often used by venture capitalists (VCs) to describe the process by which the founders of a startup gradually lose ownership of the company that they founded. As a startup that is using venture capital for funding progresses through multiple rounds of financing, the venture capitalists providing the financing will often want more and more ownership of the company that the founders must surrender in return for the capital received.

What percentage of the company should a founder hold onto, ideally, after the venture capitalists take their piece of the pie? There is no gold standard, but generally anything between (or above) 15-25% ownership for the founders is considered a success. In short, the founders dilute their ownership in the company in exchange for capital to grow their business.

BREAKING DOWN 'Diluted Founders'

When an entrepreneur or team of founders launches a startup company, the ownership of the company (or its equity shares) are divvied up among those founders, adding up to 100% in total. This allocation may be an equal split, or handed out according to perceived contribution to the new venture, duties and roles, or any other criteria. Company founders may also contribute (bootstrap) their own startup capital in the form of either cash or sweat equity. In doing so, they may be able to buy greater equity stakes from their co-founders. Eventually, growing startups will require more capital than they can bring to the table themselves and must seek outside funding. When investors agree to put money towards a startup, they receive equity shares in return - which must come out of that 100% total pie. This means that as more investors contrubute more capital to the startup, the percentage of the company owned by the founders must be diminished. Sometimes, startup founders will carve out an equity slice intended for future investors in advance, so that three co-founders may each take 25% of the equity each and leave over another 25% as a pool for VCs or other investors. Nevertheless, even this percentage will become diluted over time as seed rounds turn into Series A and Series B capital raises.

As more funding rounds occur, early investors, too, become diluted - not just initial founders. It is important to note that the trade of ownership for capital is beneficial to both venture capitalist and founder. Diluted ownership of a $500 million company is nevertheless a whole lot more valuable than sole ownership of a $5 million company.

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