This is How Startup Dilution Actually Works

Introduction

Dilution. It’s one of those buzzwords that gets thrown around a lot in the startup world, often with an air of confusion or concern. For founders raising their first round or employees receiving equity, startup dilution can feel like a mysterious process that erodes ownership. But here's the truth: dilution isn't necessarily bad. In fact, when understood and managed properly, it’s a sign of a growing, well-funded business.

At Crowdbase, our mission is to democratise startup investing. That means helping founders, investors, and even first-time backers understand how ownership changes as startups raise capital. This guide breaks down exactly how startup dilution works, how to anticipate it, and how to make smart decisions around it.

What is Startup Dilution?

The Concept of Dilution Explained

In simple terms, startup dilution happens when a company issues new shares, reducing the ownership percentage of existing shareholders. Let’s say you own 100% of your startup. Then you raise capital by giving 20% to investors. You now own 80%. That’s dilution in action.

It doesn’t mean your stake is worth less in absolute terms. If your startup grows in value, your smaller piece of the pie might still be worth more.

Common Scenarios That Lead to Dilution

• Fundraising Rounds (Seed, Series A, Series B, etc.)
• Creating an Employee Option Pool
• Convertible Notes and SAFEs Converting to Equity

Any event that increases the total number of shares will dilute existing shareholders unless they also participate proportionally in the new issuance.

How Startup Dilution Actually Works

Cap Tables and Equity Ownership

A cap table (short for capitalisation table) tracks ownership in a startup. It lists all shareholders, how many shares they own, and their ownership percentage.

Let’s say your startup has 1,000,000 shares. You own 800,000 (80%) and an angel investor owns 200,000 (20%). After raising a new round and issuing 500,000 new shares to a VC, the total number of shares is now 1,500,000. Your 800,000 shares are now 53.3%, and the angel’s stake is 13.3%. That’s dilution.

Equity Dilution in Fundraising Rounds

Whenever a company raises money, investors get a piece of the company in return for their cash. This happens by creating new shares, which slightly reduces the percentage of the company that the current owners hold — this is called dilution.

Here’s a simple example:

1. Before raising money, the company is valued at $2 million (this is called the pre-money valuation).
2. The company raises $1 million from new investors.
3. Now, the company is worth $3 million after the raise (this is the post-money valuation).
4. The new investor owns 33.3% of the company because they put in $1 million out of the $3 million total.

That means the original owners now own 66.7% instead of 100% — their share has been diluted, but the company has more cash to grow.

SAFE and Convertible Note Conversions

Convertible notes and SAFEs (Simple Agreements for Future Equity) don’t cause immediate dilution, but they convert into equity during future fundraising, often at a discount or with a valuation cap, which can lead to significant dilution at conversion.

Understanding the Math Behind Dilution

A Step-by-Step Example of Dilution Over Multiple Rounds

As funding increases, your ownership percentage drops, but the value of your equity can grow substantially.

How Option Pools Affect Founder Ownership

VCs will often require you to create or expand an option pool before they invest. This option pool is used to grant equity to employees, advisors, and future hires.

If your startup needs a 15% option pool post-investment, and the VC wants 20%, that means 35% of the company must be available post-deal. The math gets tricky here: the dilution for the founders comes from both the new investor's stake and the new option pool.

How to Manage and Minimise Dilution

Making smart decisions early can save you a lot of equity and headaches later. Here’s how to stay in control of your cap table:

• Raise with a purpose, not just because you can

  Plan funding around clear milestones (e.g., product launch, revenue targets) so you're not giving up equity you don’t need to.

• Push for a higher pre-money valuation — with data

  Justifying a strong valuation with traction, revenue, or market comps helps you keep more ownership.

• Size your option pool based on hiring needs, not investor pressure

  Don’t accept oversized pools that dilute you unnecessarily — model out what you actually need to hire in the next 12–18 months.

• Run dilution scenarios before you agree to terms

  A term sheet might look good on the surface, but use tools (like a dilution calculator or spreadsheet) to see your ownership after multiple rounds.

Convertible Notes, SAFEs, and Dilution Timing

These instruments delay dilution but can surprise founders later. They convert during priced rounds, often at a discount or cap, giving early investors a better deal than new investors, which increases dilution for founders.

Example: An investor gives you €100,000 via a SAFE with a €2M cap. If your priced round is at €4M, that investor effectively buys shares at half the price of new investors.

Pros and Cons of Startup Dilution

Why Dilution is Not Always a Bad Thing

• You're trading ownership for growth capital.
• It enables product development, hiring, and traction.
• The company becomes more valuable; your smaller piece is most likely worth more.

Risks and Downsides of Excessive Dilution

• Founder morale: If you're left with <10%, it may not feel worth it.
• Later-stage fundraising: Investors may hesitate if early dilution was too aggressive.
• Employee equity: Option pool dilution can reduce team incentives.

Key Terms Every Founder Should Know

• Cap Table: List of all shareholders and their equity.
• Pre-Money/Post-Money Valuation: Company value before and after a fundraising round.
• Convertible Note: Loan that converts to equity later.
• SAFE: Equity instrument without interest or maturity.
• Option Pool: Shares set aside for employees.
• Fully Diluted Shares: Total shares if all options/convertibles convert.
• Equity Ownership: Percentage of company owned.

Final Thoughts

Startup dilution is a natural part of growing a company. It's not something to fear—but it is something to understand and plan for. At Crowdbase, we believe every founder and investor deserves transparency and tools to navigate startup finance.

Whether you're raising your first round or investing in your first startup, understanding dilution empowers you to make smarter, more confident decisions.