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- The need for new capital: <\/strong>When private companies need more capital, they typically issue new shares to investors in a funding round, which reduces the overall percentage of ownership for existing shareholders.\u00a0<\/li>\r\n
- Increasing employee pool<\/a><\/strong>: Incoming investors usually require companies to create a stock option pool. The timing of when the stock option pool gets created determines which shareholders are diluted. Generally, if the pool is expanded before a fundraising round, only previous option holders are diluted. If the pool is expanded after a fundraising round, then all shareholders, including investors, are diluted.\u00a0<\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n
How dilution works<\/h3>\r\n\r\n\r\n\r\n
Imagine there are two co-founders of a startup and 1,000 shares issued between both. This means each founder owns 500 shares, or 50%.<\/p>\r\n\r\n\r\n\r\n
However, their company needs more capital in order to expand. A VC firm invests in the company and gets 200 shares in return. After those new shares are issued, there are now a total of 1,200 shares in the company. Each founder still owns 500 from when the startup was founded, but now their ownership stake is 42% (500\/1200) instead of 50%.<\/p>\r\n\r\n\r\n\r\n
\r\n<\/figure>\r\n<\/div>\r\n\r\n\r\n\r\n
Even though dilution causes you to own less of the company percentage-wise, it doesn\u2019t necessarily mean your stock is worth less. In fact, the price of stock (FMV)<\/a> generally increases after a funding round, so the overall value of your shares may actually go up. You just own a smaller piece of a bigger pie.<\/p>\r\n\r\n\r\n\r\n
Is accepting a new investment worth the stock dilution?<\/h3>\r\n\r\n\r\n\r\n
You can calculate stock dilution using this basic formula (which Paul Graham writes about here<\/a>):<\/p>\r\n\r\n
<\/p>\r\n
In general, if the company\u2019s value increases to more than 1 \/ (1-N)<\/strong>, it is worth it to accept the investment.\u00a0<\/p>\r\n\r\n\r\n\r\n
For example, let\u2019s say a top tier VC firm is offering capital in exchange for 10% of the company.<\/p>\r\n\r\n\r\n\r\n
\u00a01 \/ (1 – 0.1) = 1.11\u00a0<\/strong><\/p>\r\n\r\n\r\n\r\n
This means that if you believe that your company can improve its valuation by 11%, it would be worth the dilution.\u00a0<\/p>\r\n\r\n\r\n\r\n
With Carta, calculating stock dilution after each funding round is easy. Our cap table<\/a> software keeps everything up to date automatically. Learn more about Carta cap table management.\u00a0<\/a><\/p>\r\n\r\n\r\n\r\n
DISCLOSURE: This communication is on behalf of eShares Inc., d\/b\/a Carta, Inc. (“Carta”). This communication is not to be construed as legal, financial or tax advice and is for informational purposes only. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.<\/p>\r\n","protected":false},"excerpt":{"rendered":"
Stock dilution, also called equity dilution or share dilution, happens when a company issues additional shares, which reduces the ownership percentage of existing shareholders in a company. Generally, founders, employees, and investors of private companies are all subject to stock dilution. Common causes of stock dilution The need for new capital: When private companies need …<\/p>\n
- Increasing employee pool<\/a><\/strong>: Incoming investors usually require companies to create a stock option pool. The timing of when the stock option pool gets created determines which shareholders are diluted. Generally, if the pool is expanded before a fundraising round, only previous option holders are diluted. If the pool is expanded after a fundraising round, then all shareholders, including investors, are diluted.\u00a0<\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n