Equity dilution in startups is defined as the decrease in equity ownership for existing shareholders that occurs when a company issues new shares. In other words, dilution decreases a shareholder’s ownership stake in a startup. However, there are additional factors outside of issuing new stock that can also decrease a shareholder’s equity.
A subject near and dear to entrepreneurs, equity dilution is an important topic to understand for both leaders at private companies and particularly, startups. Typically, a founder starts out owning 100% of the company and, every time capital is raised, or shares are issues, the overall proportion of equity owned by the founder is reduced. Below, we go over the definition of stock dilution and provide you with a hypothetical dilution of shares example and what it can look like in action.
The Meaning of Diluted Shares
Equity Dilution takes place when a company issues new stock. Most often, this results in decrease in the ownership percentage of a shareholder. A phenomenon that goes by many names, equity dilution is also known as “founder dilution,” “stock dilution,” “private company dilution,” and “startup dilution.”
If you’ve ever made orange juice from concentrate, you can already picture how equity dilution works. When you put the concentrate in a pitcher and add water to it, the original concentrate represents only a small portion of the remaining combination. The same is true for cap tables.
Spotlight:
Stock dilution, also known as share dilution is the decrease in existing shareholders’ ownership of a company as a result of the company issuing new equity. We call this “narrow” dilution. It can also refer more broadly to the result of any action that decreases the economic value of existing shareholders’ ownership. We call this “broad” dilution.
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