Understanding the Dilution of Equity: A Guide for Startups in Central Asia

Aizhan Alisherova, city — Bishkek, Head of Acceleration Programs

Main Question: How do you evaluate?

Imagine you are offered a choice: own 100% of a company valued at $1 million, or 10% of a company valued at $100 million. The choice is obvious; mathematics favors the second option. The key is to increase the overall "pie," so that even a smaller slice is worth significantly more. The problem arises when founders, unaware, give away too many shares in the early stages, forgetting about how tools such as SAFE notes and convertible notes work.

What exactly is a SAFE. Discounts or valuation caps?

Before raising early-stage funding, many startups choose convertible debt or SAFE (Simple Agreement for Future Equity). These instruments allow raising money without immediately determining valuation, thereby delaying the impact of dilution until future events.

Dilution is inevitable once these instruments convert into shares. SAFE investors take on greater risk by investing before valuation is determined, and in return, they receive benefits such as discounts and valuation caps.

Discounts

Discounts allow SAFE investors to convert their investments at a lower price. For example, if a SAFE note provides a 20% discount, and the startup raises the next round at a $10 million valuation, SAFE investors convert their investments at an $8 million valuation, meaning they receive more shares per dollar.

Valuation Caps

A valuation cap sets a ceiling on the price at which a SAFE note converts. For example, if the cap is $5 million, and the next funding round takes place at a $10 million valuation, SAFE investors still convert their investments at a more favorable price. This protects them from excessive dilution.

What founders need to know

Founders should pay attention to two types of valuation caps: pre-money and post-money. The former sets the valuation before capital is raised, while the latter accounts for all SAFE notes and convertible instruments in the valuation. Since the update to SAFE notes by Y Combinator in 2018, post-money caps have become the standard, providing investors with greater clarity.

Why caution is important

Although SAFE notes simplify the fundraising process, careless use of these instruments can lead to founders losing more shares than expected. Questions to ask before signing a SAFE agreement include:

— what share of shares SAFE investors will receive under various future valuations

— will I still own a significant stake in my company after conversion

— how the terms will affect my ability to raise investment from venture capitalists.

Strategy for managing dilution

Raising capital is not just about obtaining funding; it is also about managing dilution.

Institutional venture capitalists are often reluctant to invest when founders have already given away too many shares. If early investors hold too large a share, this can create friction in future funding rounds, making it difficult to raise money on favorable terms.

If you are interested in learning more and would like to develop your own investment strategy, there is such an opportunity specifically for startups in Central Asia by participating in the pre-acceleration program from Accelerate Prosperity as part of the Central Asian Startup Cup, the finals of which will take place on April 24-25 in Bishkek.

Participation is open to startups from all Central Asian countries: Kazakhstan, Kyrgyzstan, Uzbekistan, Tajikistan, Turkmenistan.

Registration is open until March 17. As part of the program, you will receive:

— access to an educational program with practicing mentors and experts

— $10,000 equity-free cash prize

— networking with leading venture investors in the Central Asian region

— a chance to make it into the top 25 and subsequent program with a $100,000 fund

— the opportunity to receive feedback from more than 10 leading venture investors in the region

— structured cap tables to visualize how different SAFE note terms will affect your stake. This will help avoid surprises in subsequent funding rounds.

Applications:

1. CASC Architecture in English and Russian — link.
2. CASC Program in English and Russian — link.
3. Full information about CASC for partners, startups, speakers, and anyone you want to share more detailed information with in Russian — link.