Route 1 for founders of UK tech ventures invariably involves subscribing for shares in a new limited company on incorporation before navigating the company through a series of equity funding rounds at exponential valuations before cashing out a significant percentage shareholding at exit.
That's usually the plan, anyway. But funding rounds with a flat valuation and the dreaded 'down round' will usually see the size of the founders' percentage shareholdings much diminished and perhaps with it the dream of a life changing return at exit. That can be a particularly unpleasant experience if the valuation of the round has triggered an anti-dilution ratchet.
But if the company has to raise the funds and doing so at a sub-optimal valuation is the only offer on the table, then the founders seldom have much choice but to go along with it and suffer the dilution.
Or do they? There are ways in which founder equity can be topped up, for example by using a structure where returns to the founder from the additional equity are driven only by value accrued from the point in time of the top up. This may align with the investors' perspective whilst at the same time avoiding the obvious tax problems that would otherwise bite where valuable equity is given to employees for free or at less than market value.
The means of achieving this are never completely simple. There may be a number of complicating factors such as the need to balance the interests of founders and investors, valuation considerations and (given the complex nature of the task at hand) the cost of the advice. However, before you throw founder equity top ups into the 'too complicated' basket – which often happens – make yourself a cup of tea and read on below.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
