Jean-Louis Gassée, writing for Monday Note, lays out some basic VC thinking. If you want to build a company, you’ll likely start by self-funding. Then you’ll turn to family and friends, perhaps an angel or two. But if the idea is too big to build from that pool, you’ll turn to venture capital.

If you have an entrepreneur inside you, this is a good read. Especially this last bit, which walks through some basic (albeit extreme) VC math:

At the first round of financing, Investor A buys 50% of company, say 50 shares for $10M. Management, family, friends and other investors own the other 50 shares.

Trouble happens, the product is late, the economy… The company is running out of money. Family and friends are tapped out. With one exception, the investor group is running away. In the absence of other sources, the remaining more courageous Investor A is now in a position to dictate terms.

For another $10M, the re-upping Investor A wants 900 new shares.

There are now 1,000 shares. Investor A owns 900 (second round) + 50 (first round) shares, 95% of the company. The rest (family, friends, other investors) used to own 50% of the company, their 50 shares now represent 5% ownership. This is a muscular dilution.

The pros shrug it off, they know the rule. Family and friends are indignant, especially if, after the refinancing, the entrepreneur gets a fresh grant of option to keep him/her motivated.

Hardball.