Launching a startup is a lot like the age-old question: which came first, the chicken or the egg? Do you invest in your product or validate your market first? The question has plagued entrepreneurs for years. But one thing is clear: dilution can be a serious issue for startups, and founders need to be strategic in avoiding it. In this article we explain how breaking down the product journey into 4 segments can de-risk your business and reduce the negative impacts of dilution when seeking equity investment.
What is Shareholder Dilution?
As a startup founder, raising funds is often necessary to grow your business and achieve your goals. But this process can also result in shareholder dilution – the reduction of an individual’s ownership percentage in a company as a result of the issuance of new shares.
Dilution is a common occurrence in the startup world and happens when companies seek to raise funds from venture capitalists or angel investors. When equity is issued to these investors in exchange for cash, the ownership percentage of existing shareholders (usually the founders and early employees) is reduced.
It’s a necessary evil when raising funds, but can have a negative impact on the founding team's ownership and control of the company if not managed properly. On the flip side, it’s not all bad because if you get the right investors on board, their expertise and connections (along with their vested interest in your success) can be worth its weight in gold.
Avoiding Dilution When Seeking Startup Funding
When a startup appears more risky, investors will demand a greater percentage of equity in exchange for their investment. Therefore, de-risking your product before seeking investment is a good strategy to reduce dilution. De-risking can be achieved through various methods, such as conducting thorough market research, obtaining early customer feedback, building a minimum viable product (MVP), and demonstrating traction. By de-risking your product, you increase its value and attractiveness to investors, which can lead to a more favourable investment deal with less dilution.
How to De-Risk Your Startup to avoid Dilution
Dilution occurs on an entity level, but to avoid it, the focus should be on the product. Think about it. An investor would only be interested in your business if you have a strong product and/or the delivery system for it.
By breaking down the product development journey into 4 segments, you’ll de-risk your startup and be in a better position to seek investment. And as we go through them, we’ll share how leaning on non-dilutive funding sources can reduce dilution even further.
1. Product Validation
Build the engine before building the rocket ship. If you have an experimental product or business model, your first objective should be to validate the idea. While the aim is getting into space, you’ll never leave orbit unless you have an engine that can produce enough power. Your seed funding should be used to hypothesise the key ingredients that will get you to lift off.
Funding and Support for Product Validation
Why build a science lab in your backyard when you can partner with your local university to test your hypothesis? These institutions tend to be well funded and have a lot of pull with both public and private money.
- Technical assistance from research partners, such as tertiary education institutions and government research institutions such CSIRO
- Government incentives, such as the Research & Development Tax Incentives that give up 48.5% of eligible expenditure
- Customer-funded product development, including revenue sharing agreements .
2. Market Validation
Simply put, if you’re invisible, then so is your product. Market validation involves both getting the word out that your product is coming and getting feedback on the product–market fit.
Funding and Support for Market Validation
- Market validation schemes such as Landing Pads or the MVP Ventures Program are government-funded programs providing funding to help businesses validate their products or services in new markets. These programs support you to prioritise markets, validate market entry plans and check readiness for expansion by providing advice, connections and in some cases funding, to help execute on market entry.
- The Entrepreneur's Programme is a government-funded program that provides funding and support to businesses that are looking to grow and expand. The programme can be a good option for businesses that are looking to validate their business model in a new market, as it provides access to a range of resources and support to help businesses succeed.
- The Industry Growth Centres program provides funding and support to businesses in select industries. The program helps startups looking to validate their business model via workshops and training, international trade show participation, project funding and more.
3. Product Mastery
Product mastery refers to the level of expertise and knowledge a startup has in regards to their product, including its features, functionalities, and target audience. It involves continuous learning, testing, and iteration to ensure that the product is meeting the needs of the market and is differentiated from competitors.
As you achieve mastery of your product or service, consider non-dilutive funding through partnerships or licensing agreements . These types of arrangements allow you to work with other companies to bring your product to market, without giving up equity in your business.
Funding and Support for Product Mastery
In Australia, there are several grant programmes that may be available to businesses working to achieve product mastery. Consider these options:
- AusIndustry is a government agency that offers funding and support to businesses through several programs, including the Accelerating Commercialisation program . This program provides funding to help businesses introduce innovative products or services to the market, making it a valuable option for businesses that strive for product mastery.
- The Research and Development Tax Incentive is a government initiative that provides tax credits to businesses undertaking R&D activities. This can be a valuable option for companies striving to develop new technologies or improve existing products.
- The Cooperative Research Centres (CRC) program brings together researchers and businesses to work on innovative projects. For businesses working to achieve product mastery, it provides access to both research expertise and funding.
4. Market Expansion
Expanding into new markets and increasing the customer base can increase a startup's valuation and reduce equity dilution. A proven track record of success and growth strategy can also make the startup more attractive to investors and increase negotiating power.
Funding and Support for Market Expansion
- The Export Market Development Grants (EMDG) is a government-funded program that assists businesses in developing new export markets by covering the costs of related activities such as marketing and advertising.
- Export Finance Australia is a government-owned corporation that assists businesses with funding solutions to boost working capital, purchase new equipment, grow online and expand internationally.
Ready to Swim With the Sharks and Seek Equity Funding?
Dilution is a common challenge faced by startups when raising funds, but it can be managed by de-risking the product and exploring non-dilutive funding options. By breaking down the product journey into segments and leveraging the right resources, founders can reduce dilution and make their product more attractive to investors. If you need help with your startup journey and getting the funding you need to scale up fast, our startup business advisors are here to assist you. Get in touch with our startup accountants and lawyers to learn more.
