How does equity dilution work across funding rounds?

Full Explanation

Dilution is the mathematical consequence of creating new shares. When a startup raises a funding round, it issues new shares to investors, increasing the total share count and reducing each existing shareholder's percentage ownership. Understanding how dilution works across multiple rounds is essential for founders, employees with equity, and early investors. Consider a founder who owns 100% of 1 million shares. At a seed round, 250,000 new shares are issued to investors — the founder now owns 80% (1M of 1.25M shares). At Series A, another 416,667 shares are issued — the founder owns 62% (1M of 1.67M shares). By Series B, with further issuance, the founder might own 45-50%. This cascade of dilution is normal and expected. Critically, dilution of ownership percentage does not mean dilution of value. If the founder owned 100% of a company worth £1 million and now owns 50% of a company worth £20 million, their stake value increased from £1 million to £10 million despite 50% dilution. This is why investors focus on 'value accretive' dilution — accepting ownership reduction because each pound of investment increases the company's value by more than a pound. Factors that amplify dilution include: option pool creation or expansion (typically 10-20% reserved for employees), SAFE or convertible note conversions (which create additional shares at potentially lower prices), anti-dilution protections triggered by down rounds, and multiple bridge rounds between major financings. Founders should model dilution across projected future rounds using a cap table tool, understand the cumulative effect of each decision, and negotiate valuation and option pool sizes with dilution impact in mind.

Related Glossary Terms

Related Questions