Dilution occurs when a company issues new shares, reducing the ownership percentage of existing shareholders proportionally. If you own 10% of a company with 1 million shares outstanding and the company issues 500,000 new shares to investors, your ownership stake drops to 6.67% even though you still hold the same number of shares.
This reduction happens because the total share count increases while your absolute number of shares remains constant. The math is straightforward: your shares divided by the new total equals your diluted ownership percentage. Companies typically issue new shares during funding rounds, employee stock option exercises, or convertible note conversions.
Why It Matters
Dilution directly impacts your potential returns and voting power. A 20% stake worth $2 million at a $10 million valuation becomes a 10% stake if the next round doubles the share count—you'd need a $20 million exit to maintain the same $2 million return. Smart investors negotiate anti-dilution provisions to protect against down rounds and calculate their fully diluted ownership percentage before investing. The difference between owning 15% versus 8% of a successful exit can mean millions of dollars in your pocket.
Example
Sarah invests $500,000 in a startup's Series A at a $5 million pre-money valuation, receiving 10% ownership (500,000 shares of 5 million total). Two years later, the company raises a Series B at a $15 million pre-money valuation, issuing 1.5 million new shares to new investors for $5 million. Sarah's 500,000 shares now represent just 7.7% of the company (500,000 ÷ 6.5 million total shares). Her stake is worth $1.15 million at the new valuation—she's made money, but her ownership percentage decreased by 23%. If the company had raised at a $10 million valuation instead, issuing 2.5 million shares, Sarah's dilution would be even more severe at 5.6% ownership.
Related Terms
Anti-Dilution Provisions, Pre-Money Valuation, Employee Stock Option Pool