What Is Equity Dilution? A Founder's Guide With Examples
What is equity dilution? See how new rounds, option pools and SAFEs shrink your percentage, with step-by-step examples so you can work out your own stake.
What is equity dilution? Equity dilution is the fall in an existing owner's percentage of a company when the company creates new shares. Your number of shares stays the same, but the total grows, so your slice of the whole gets smaller. It happens when you raise money, set up an option pool, or when a SAFE or convertible note turns into shares.
Dilution is normal and often healthy. A smaller percentage of a company that is worth more can be worth more than a bigger percentage of a company that cannot grow. This guide shows the arithmetic step by step, so you can calculate your own numbers before you sit down with an investor.
What is equity dilution? A worked example
Ownership percentage is simple: your shares divided by all shares. Dilution changes the bottom number.
Example: a seed round. Two founders hold 5,000,000 shares each, 10,000,000 in total, so 50% each. An investor puts in €500,000 at a €2,000,000 pre-money valuation. Pre-money is the value of the company before the new money.
- Post-money valuation = €2,000,000 + €500,000 = €2,500,000.
- Investor's share = €500,000 / €2,500,000 = 20%.
- Price per share = €2,000,000 / 10,000,000 = €0.20, so the investor receives €500,000 / €0.20 = 2,500,000 new shares.
- Total shares = 10,000,000 + 2,500,000 = 12,500,000.
- Each founder now owns 5,000,000 / 12,500,000 = 40%.
Each founder was diluted from 50% to 40%, a loss of 10 percentage points. Now compare value. Before the round, 50% of €2,000,000 is €1,000,000. After the round, 40% of €2,500,000 is also €1,000,000. The percentage fell, the value of the stake did not, and the company now holds €500,000 of new cash. That is the key idea. Dilution costs you value only if the money does not make the company worth more.
The main causes of dilution
| Cause | What happens | Who bears it |
|---|---|---|
| New investment round | The company issues shares for cash | All existing holders, in proportion |
| Option pool | Shares are reserved for future hires, or the pool is topped up | Existing holders, or everyone, depending on timing |
| SAFE or convertible note converting | Early money turns into shares at the next priced round | Existing holders, mainly founders |
| Employees exercising options | Granted options become real shares | All holders, slightly |
| Anti-dilution adjustment | After a lower-priced round, some earlier investors get extra shares | Founders and other holders without that protection |
A secondary sale, where an existing holder sells shares to someone else, does not create new shares. It changes who owns the shares but dilutes nobody.
How a round and an option pool dilute you together
Investors often ask for an option pool to be included in the pre-money valuation. This is known as the option pool shuffle. The pool shares are created before the investor buys, so the investor's percentage is protected and the existing holders absorb the dilution.
Example: a Series A. Continue from the seed round. Founders hold 40% each and the seed investor 20%. A new investor puts in €3,000,000 at a €9,000,000 pre-money valuation, and asks for a new option pool of 10% of the company after the round.
- Post-money valuation = €9,000,000 + €3,000,000 = €12,000,000.
- New investor = €3,000,000 / €12,000,000 = 25%.
- New pool = 10%.
- Everyone who held shares before gets what is left: 100% − 25% − 10% = 65%.
- Each founder: 40% x 65% = 26%. Seed investor: 20% x 65% = 13%.
| Holder | Before Series A | After, no pool | After, with 10% pool in pre-money |
|---|---|---|---|
| Founder A | 40% | 30% | 26% |
| Founder B | 40% | 30% | 26% |
| Seed investor | 20% | 15% | 13% |
| Series A investor | 0% | 25% | 25% |
| Option pool | 0% | 0% | 10% |
| Total | 100% | 100% | 100% |
Check the "no pool" column: 40% x 75% = 30%, and 20% x 75% = 15%. The pool costs each founder 4 percentage points (30% to 26%). The pool also lowers what the existing holders are really paid for. Of the €9,000,000 pre-money, 10% of €12,000,000 = €1,200,000 goes to the pool, so the existing holders are valued at €9,000,000 − €1,200,000 = €7,800,000. Check: 65% of €12,000,000 = €7,800,000. Each founder's stake is now worth 26% of €12,000,000 = €3,120,000, up from €1,000,000 at the seed. Founders were diluted twice and still hold a stake worth three times more, because the company grew in value.
The pool is not wasted. It is equity you will give to people you hire. But it should match a real hiring plan. Ask what the pool is for and how many grants it covers. For the full list of what sits on a cap table, see what is a cap table.
How SAFEs and convertible notes dilute you later
A SAFE (Simple Agreement for Future Equity) was created at Y Combinator in 2013. The investor pays now and gets shares when you raise your next priced round. Nothing changes on the share count today, so the dilution is delayed and easy to forget.
Example. You hold 100% of the company. You sign a SAFE for €100,000 with a €1,000,000 post-money valuation cap. With a post-money cap, the ownership the SAFE buys is the investment divided by the cap: €100,000 / €1,000,000 = 10%. You hold 90%. A priced round then gives a new investor 20%. Everyone else is diluted by that round: 90% x 80% = 72% for you, and 10% x 80% = 8% for the SAFE holder, before any option pool.
A convertible note is a loan that turns into shares and adds interest to the amount that converts, so it can dilute you slightly more. Both are covered in SAFE notes explained and convertible notes explained. Always add all your SAFEs and notes to a model of the next round, because they arrive together.
When dilution hurts: lower-priced rounds
A round at a lower valuation than the previous one is a down round. The same cash buys a bigger share of a smaller company.
Example. After the seed, the company is worth €2,500,000. A year later it has not grown as planned. A new investor puts in €500,000 at a €1,000,000 pre-money valuation. Post-money is €1,500,000, so the investor receives €500,000 / €1,500,000 = 33.3%. Existing holders keep 66.7%. A founder falls from 40% to 40% x 66.7% = 26.7%. Value falls too: before, 40% of €2,500,000 = €1,000,000. After, 26.7% of €1,500,000 = €400,000.
Some investor agreements include anti-dilution protection. This gives earlier investors extra shares after a down round, which pushes more dilution onto the founders. Read these terms closely and ask a lawyer to explain them.
How to decide how much dilution is acceptable
There is no correct percentage to give up. Use three checks instead of a rule of thumb.
- What does the money buy? If it buys enough runway to reach a clear milestone, the dilution pays for itself. If it only delays the problem, it does not.
- What is your stake worth afterwards? Multiply your new percentage by the post-money valuation, as in the examples above. Compare it with what you hold today.
- What will you need next? Model the next round before you accept this one. Include the pool, every SAFE and every note. If you end up with a stake that no longer motivates you, say so now, not after signing.
Frequently asked questions
How do you calculate equity dilution?
Divide your shares by the new total number of shares. Or multiply your old percentage by the share of the company that existing holders keep. In the seed example, 50% x 80% = 40%.
Is equity dilution bad?
No, not by itself. You give up a percentage to get money, skills or reach that make the company worth more. It is bad when the percentage falls and the value of the company does not rise, as in a down round.
Can you avoid dilution?
You can reduce it by raising less, raising later at a higher valuation, or growing from revenue. You cannot avoid it if you raise equity money or give equity to a team. Some investors have the right to buy more shares in later rounds to keep their own percentage, which does not help the founders.
Does dilution affect founders and employees equally?
Every holder of existing shares is diluted by a new round, in proportion. A new option pool can fall only on existing holders if it is created before the investment. Employees who hold options are diluted in the same way, until they exercise.
What is the difference between dilution and a down round?
Dilution happens in every round that issues shares. A down round is a round at a lower valuation than before, so you lose percentage and value together.
This is general education, not legal or tax advice. Instrument names, tax treatment of equity and the formalities of issuing shares differ by country. Check the details with a lawyer where your company is registered.
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