Software Growth

Dilution

Dilution is the drop in an existing owner's percentage when a company issues new shares to investors, employees or others.

Dilution happens when a company issues new shares and your slice of the total shrinks. You own the same number of shares, but they are a smaller percentage. Whether that is bad depends on what the new capital does: owning 80 percent of a company worth $1M is worth less than owning 60 percent of one worth $5M.

How to calculate dilution

Equivalently, if new investors end up with 20 percent of the company after the round, everyone existing keeps 80 percent of what they had. Share-count version: you hold 8,000,000 of 10,000,000 shares (80 percent). The company issues 2,000,000 new shares. You still hold 8,000,000, but of 12,000,000, so you own 66.7 percent.

Worked example across rounds

Two founders each own 50 percent. In a seed round, an investor puts in $1M at a $4M pre-money valuation. Post-money is $5M, so the investor owns 1 / 5 = 20 percent and each founder falls to 40 percent.

Later, a Series A raises $5M at a $15M pre-money valuation. Post-money is $20M, so new investors own 25 percent. Each founder now holds 40 percent x (1 - 0.25) = 30 percent. Together the founders own 60 percent. Carta's data, summarized in this guide to equity dilution, puts typical dilution around 20 percent at seed and Series A, and 10 to 15 percent in later rounds.

Sources of dilution

  • Priced rounds, where new investors buy shares.
  • SAFEs and convertible notes when they convert.
  • Growing the employee option pool, often required before a round closes.
  • Equity grants to hires, advisors and co-founders.

Pool increases are often negotiated as part of the pre-money valuation, which means existing holders absorb the dilution, not the new investor. Always model the pool in your cap table.

Managing it

  • Raise less, or later, when your terms are stronger.
  • Use non-dilutive capital such as revenue-based financing when you have recurring revenue.
  • Compare dilution against what the money will add to company value, not in isolation.

Investors with pro rata rights can offset their own dilution by investing again; founders cannot do the same without buying shares. Bootstrapped founders who never sell equity keep their full percentage, which is part of the appeal.

Sources

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