When you invest in a startup you buy equity, a slice of ownership measured in shares. The catch is that the slice is not fixed. It can shrink as the company issues more shares, and it can sit behind other people who get paid before you if the company sells.
If you came from the video, that's the shape of it. Here's the part that doesn't fit in sixty seconds: what each of those words does to your money, one deal worked all the way through with real numbers, and the term-sheet questions I ask before I agree to anything.
What you're actually buying
Four ideas do almost all the work here. Get these and you can read most of what a founder sends you.
Shares
Shares are the units of ownership. Your stake is your shares divided by every share that exists, the "fully diluted" count, not just the ones sold to investors. Always ask for that total number. "You'll own 1%" means nothing until you know the denominator.
Dilution
When the company issues new shares to raise money or pay staff, the total count grows. Your shares stay the same, so your percentage drops. This is normal and usually a good sign: it means the company raised more money. The number to watch is not that you get diluted, but how much, and whether the round that dilutes you also raises the value of what you hold.
The option pool
Shares set aside to hire and keep employees. It dilutes everyone, and founders often expand it right before a raise so the new investor is not the one paying for it. If a term sheet mentions a new or bigger pool, ask whether it comes out of everyone's slice or just yours.
Liquidation preference
The rule for who gets paid first if the company sells. A "1x preference" means those investors take their money back before common shareholders see a cent. It is why a sale can look fine in the headline and pay you almost nothing. This is the single term I read most carefully, because it can quietly rewrite the whole outcome.
One deal, worked all the way through
Say your friend Maya is starting a coffee-roasting company and you put in 5,000 dollars. Abstract percentages are easy to nod at and hard to feel, so let's follow this one to the end.
At the raise the company is valued at 500,000 dollars and has 1,000,000 shares. Your 5,000 dollars buys you 10,000 shares, which is 1%. So far it matches the headline.
A year later the roastery raises a bigger round and issues 500,000 new shares, so 1,500,000 shares now exist. You still hold your 10,000, but that is about 0.67%. You did not lose shares, the pie got bigger, and if the round was priced higher your stake is worth more even as the percentage falls. That is dilution working the way it should.
Two years on, a regional grocery chain buys the roastery for 2,000,000 dollars. Here is where the preference bites. The later investors put in 300,000 dollars with a 1x liquidation preference, so they take their 300,000 dollars back first, leaving 1,700,000 dollars to split by ownership. Your 0.67% of 1,700,000 dollars is about 11,300 dollars, not the 13,400 dollars you'd get from 0.67% of the full 2,000,000 dollars. Still more than double your money, but the preference and the dilution both moved the number, and neither showed up in "you own 1%."
Your percentage is a moving number, and it usually sits behind someone else's money. The two questions that decide your outcome are: how much will I be diluted over time, and who gets paid before me if this sells?
The questions I ask before I wire the money
You do not need a lawyer to ask these, and asking them tells you as much about the founder as the answers do. A founder who can explain their own cap table is a good sign. One who gets cagey is a different kind of signal. Here is the list I run down every time, worth keeping in your notes.
Ownership
- How many shares total, fully diluted, after this round?
- What percentage does my check buy at that count?
- Am I buying common shares or preferred? What is the difference here?
Dilution
- How much more do you expect to raise, and roughly when?
- Is there an option pool being created or expanded? Whose shares does it come out of?
- Do I have pro-rata rights to invest again and keep my percentage?
Getting paid
- What is the liquidation preference, and is it 1x or higher?
- Is it participating or non-participating? (Participating means they take
their money back AND share the rest. Ask which one.)
- If the company sells for the amount we invested at, what do I actually receive?
Paper trail
- Can I see the current cap table?
- Is this priced equity, or a SAFE or note that converts later? At what cap?If a term is written as a SAFE or a convertible note rather than a priced round, your shares and percentage are not fixed yet, they convert at the next round based on a valuation cap. That is fine, common even, but it means "1%" is an estimate until the cap and the next raise decide it. Ask what the cap is and what percentage it implies.
What goes wrong, and what to watch for
The mistake I see most is anchoring on the percentage and ignoring the preference stack. Someone tells you 1% of a company that might sell for 50 million dollars and you do the happy math. But if three rounds of investors sit ahead of you, each with a preference, a modest sale can clear their money and leave common holders with a rounding error. Read the stack, not just your slice.
The second is treating dilution as theft. It is not. A founder issuing shares to raise a strong round at a higher price makes your stake more valuable even as the percentage falls. The bad version is a "down round," dilution at a flat or lower valuation, which shrinks both your percentage and your value. Ask what price the new shares were issued at, not just how many.
The third is skipping the difference between common and preferred shares. Founders and early investors often hold preferred, with the preferences and voting rights attached. Friends-and-family money is frequently plain common, last in line. That can be a fine deal, but know which one you're being offered and price the risk accordingly.
The last is confusing a good business with a good deal. Maya's roastery could be a wonderful company and still a poor investment if you buy in at a price that leaves no room, or behind terms that pay you last. Judge the company on its own merits with the research a business framework, and if it's an AI startup, add the extra questions in what I'd want to know before investing in an AI startup.