Startup Vocabulary

Dilution

Equity dilution works when the same pie is divided among more people. The founder of a company starts by owning all the shares representing ownership of the company. Over time, other people receive pieces of equity in exchange for work (employee stock options), money (seed, angel and venture investors), or services (attorneys, directors, etc.) Because the total percentage of equity will always equal exactly 100%, every time anyone gets another piece, by definition it “dilutes” all of the previous equity holders.
Reading Time: 1 minute (Quick Read)

Dilution

What is dilution?

Dilution is a reduction of the total percentage (%) of a company owned by an entity when new shares are issued.

For example, let’s say you own 1,000 shares of a Company ABC. When 100 new shares of ABC is issued to a new investor or shareholder, what happens to your ownership percentage?

  • Total number of shares (before): 1,000 shares
  • Total number of shares (after) : 1,100 shares
  • So, you own 1,000 shares out of 1,100 shares: (1,000/1,100) x 100=91%

With the issuance of the 100 new shares, your ownership of the company dropped from 100% to 91%. This is called a 9% dilution.

Note: Although your ownership percentage in company ABC has dropped, the absolute value of the stock in dollars and cents would have increased (typically, unless it’s a down round).

Dilution typically happens in 3 scenarios:
1. When you are raising capital: As shown above, if you have a new investor who injected cash into your company, you will be diluted.
2. If you issue stock options or warrants: A stock option or warrant owner can decide when they would like to enter your capital structure. Hence, when they do, you will face a dilution.
3. When you have raised using convertible debt: Convertible debt means that they loan that you took can be converted to equity when a trigger event happens. The trigger event is normally negotiated when you get the loan. So, when the event happens, you will be facing a dilution.

Get two books for free

Get this book in audio and another audiobook of your choice for free through Amazon Audible.

Do you want more?

Find out how you can get more such as audio versions of the summary, online QnA  and also host us at your work or school!