Equity Dilution

What Equity Dilution means in practice

Dilution is the arithmetic consequence of issuing new shares: your share count stays the same while the total grows, so your percentage falls. It is not inherently bad — a smaller share of a much larger company is usually worth more — but it compounds across rounds in ways founders routinely underestimate.

The compounding is what surprises people. Each round dilutes the post-round position of the previous one, so successive rounds of 20%, 20% and 15% do not sum to 55%; they multiply, leaving roughly 54% of the original stake. Modelling several rounds ahead reveals an ownership position very different from adding the percentages.

Option pools are the most commonly missed source. Investors typically require the pool to be created or expanded *before* the round, meaning existing shareholders absorb that dilution alone while the incoming investor's stake is unaffected. A 10% pool created pre-money is materially more expensive to founders than the same pool created post-money.

How it is calculated

Worked example

A founder starting with 100% across two rounds and an option pool.

• Seed: 20% sold → founder at 80%.
• Option pool of 10% created pre-money at Series A → founder to ~72%.
• Series A: 20% sold → founder to ~57.6%.
• Adding the percentages would have suggested 50% sold; the real position is 57.6% retained.

Takeaway: The pre-money option pool cost the founder 8 percentage points that the investor did not share — the single most overlooked line in a term sheet.

Common mistakes

• Adding dilution percentages across rounds instead of compounding them.
• Overlooking that pre-money option pools dilute existing shareholders alone.
• Optimising to minimise dilution at the cost of taking too little capital to reach the next milestone.
• Ignoring liquidation preferences, which can matter more than percentage ownership in a modest exit.

Related tool: Equity dilution calculator.

Related terms

• Bootstrapping — Bootstrapping is building a company using revenue and personal funds rather than external investment, retaining full ownership and control at the cost of slower growth.
• Runway — Runway is the number of months a company can continue operating before it runs out of cash, calculated by dividing cash reserves by net monthly burn.
• Burn Rate — Burn rate is the speed at which a company spends its cash reserves, usually expressed per month. Net burn is spending minus revenue; gross burn is total spending regardless of income.