Equity dilution is a typical and often unavoidable aspect of a startup’s development. Yet, it is not necessarily the same as a loss of control or value. If the company’s value goes up substantially, the remaining stake can be very valuable, and founders can still have considerable influence—however, it is not guaranteed that they will have majority control. Those who are well-experienced and take a positive, tactical approach to equity dilution are certainly in a better position to maintain their influence and gain financial rewards.
In this article, we provide detailed practical methods that founders can use to limit the impact of equity dilution, retain more ownership, and guarantee they remain the decision-makers in their company’s future. Let’s get started.
What is equity dilution?
Equity dilution is the reduction in ownership percentage that occurs when a company issues new shares. The number of outstanding shares of the company increases when new shares are issued. If current shareholders decide not to buy any more shares, the number of shares they hold stays the same, but their proportion of ownership in the company becomes lower due to the rising total number of shares.
Equity dilution may occur during mergers, acquisitions, fundraising cycles, or when employees exercise their stock options.
When does equity dilution occur and how does it work?
Existing shareholders experience equity dilution when a company creates new shares, reducing their ownership percentages. This is most often seen in three primary scenarios:
- Fundraising: In a fundraising process, investors are given newly issued shares in return for their capital, which consequently reduces the ownership percentage of existing shareholders.
- Convertible debt: A debt structure that permits the principal and accrued interest to be converted into an equity investment at a later date is known as convertible debt. Debt holders are converted into shareholders due to a trigger event, such as an exit or fundraising round. Consequently, the primary shareholders’ ownership stake is diminished.
- Stock options: Stock options let you buy shares in the future, and new shares are typically created only when you use those options.
The dilution process follows a predictable pattern:
In the beginning, a company gives shares to its founders and early investors, setting up the initial ownership structure. As the business grows and needs more funding, it issues new shares to investors or option holders. When this happens, existing shareholders still own the same number of shares, but their ownership percentage shrinks because the overall number of shares has increased. This may impact not only the company’s valuation per share but also voting control, depending on the quantity and price of the new shares in relation to the existing ones.
Founders who understand dilution can help shareholders see it as a good thing. They can show that new investment helps the business grow, so even if someone owns a smaller share, each share could be worth more in the future.
Examples of equity dilution
We will examine several instances of stock dilution in action:
Startup scenario
Let’s say a startup has 100,000 outstanding shares, and you own 10,000 shares, representing 10% of the company. The company raises capital by issuing 20,000 new shares, bringing the total number of shares to 120,000. Your 10,000 shares now represent only 8.33% of the company.
Calculation:
- Before: 10,000 / 100,000 * 100 = 10%
- After: 10,000 / 120,000 * 100 = 8.33%
Ownership Change Table
| Scenario | Total Shares | Your Shares | Your Ownership % |
| Before Dilution | 100,000 | 10,000 | 10% |
| After Dilution | 120,000 | 10,000 | 8.33% |
Employee stock options
Consider a startup with 200,000 outstanding shares. As part of its compensation package, the organization grants employees 20,000 stock options. Employees are given the opportunity to acquire shares at a predetermined price through these options. If every employee were to exercise their options, the total outstanding shares would become 220,000. In such a case, the ownership percentage of all existing shareholders, including founders and investors, would be diluted unless they choose to increase their shareholding by purchasing more shares.
For instance, if you hold 40,000 shares:
- Before: 40,000 / 200,000 * 100 = 20%
- After: 40,000 / 220,000 * 100 = 18.18%
Ownership Change Table
| Scenario | Total Shares | Your Shares | Your Ownership % |
| Before Exercise | 200,000 | 40,000 | 20% |
| After Exercise | 220,000 | 40,000 | 18.18% |
Convertible securities scenario
Let’s say an investor with a convertible note puts in $100,000 at a 20% discount. They will receive more shares than a new investor who puts in $100,000 at full price. This increases the total number of shares, reducing the ownership percentage of existing shareholders who did not participate in the new round.
Let’s see how this actually works with some numbers:
- Assume there are already 1,000,000 shares in the company.
- A new investor pays $1.00 per share.
- The convertible note investor gets a 20% discount, so they pay $0.80 per share.
Here’s how the shares work out for each:
- Convertible Note Investor: $100,000 / $0.80 = 125,000 shares
- New Investor: $100,000 / $1.00 = 100,000 shares
Now, add up all the shares after both invest:
1,000,000 (existing) + 125,000 (note) + 100,000 (new) = 1,225,000 shares
Now, let’s figure out who owns what percentage of the company:
- Existing Shareholders: (1,000,000 / 1,225,000) × 100 ≈ 81.6%
- Convertible Note Investor: (125,000 / 1,225,000) × 100 ≈ 10.2%
- New Investor: (100,000 / 1,225,000) × 100 ≈ 8.2%
| Scenario | Shares Owned | Ownership Percentage (Approx.) |
| Existing Shareholders | 1,000,000 | 81.6% |
| Convertible Note Holder | 125,000 | 10.2% |
| New Investor | 100,000 | 8.2% |
How Does Equity Dilution Impact You and Your Startup?
Equity dilution does more than simply change your finances; it affects your control and share of the company. Share dilution may have the following effects on you:
- Decreased Ownership Stake: When equity dilution takes place, the percentage of your stake in the company is reduced. This means that your share in the business will be smaller. Consequently, you might receive a smaller portion of the dividends distributed or the proceeds from the sale of the business if the company’s value has not increased sufficiently to offset the dilution.
- Influence on Decision-Making: If the company issues additional shares and you do not acquire a proportional number of them, your voting power will be reduced. This can lead to decisions being made without your agreement, especially if new investors have different goals.
- Employee Motivation and Retention: Giving employees equity, like stock options, is a common way to attract and keep good talent. However, if their ownership gets diluted too much, it can make them feel less motivated and less committed to the company.
- Appeal to Investors: Selling more shares reduces your share of the company, but it helps bring in new investors who see the potential in your startup. Finding the balance between ownership and funding is key.
- Impact on Company Valuation: Dilution affects both your level of ownership and the potential value of each share. Your financial stake may decrease over time if the company’s valuation does not increase enough to offset the dilution of your ownership.
Strategies for Managing Equity Dilution
Equity dilution is generally unavoidable; however, it does not necessarily have to be beyond your control. The following are some methods you can use to manage equity dilution:
Prepare for Multiple Fundraising Rounds
Be ready for the fact that your business might need to raise money more than once. A cap table helps you see how each round of funding could impact your ownership. When you plan ahead, you’re better prepared to handle situations like down rounds and keep dilution under control.
Raise Capital Wisely
Be careful with funding rounds—you might think a big raise means you’re winning or that it will automatically kickstart growth, but that’s not always the case for an early-stage startup. While raising significant capital can help expand the organization, it may also lead to inefficient spending and distract from the core business strategy.
Plan Ahead with Cap Tables
A cap table shows how many shares each person owns and what percentage of the company they hold. It’s a handy tool for tracking your ownership as the business grows.
It can be used in a variety of ways to address specific questions, such as modeling the potential impact of various funding options on the dilution of existing shareholders and the value of their stakes. Alternatively, it can be employed to simulate the effects of a series of future funding rounds in order to guide the development of comprehensive business plans and identify potential exit scenarios.
Investor Alignment and Selection
Almost all investors will possess a set of outlines that assist them in identifying the types of companies and transactions they are seeking. Many concentrate on Series A or B rounds, but this is not always the case. Some investors are looking for a big stake in the company (for example, 20%); however, this depends on the individual investor and the transaction. Understanding investor expectations helps founders align with the right partners and negotiate better terms, which can help minimize unnecessary dilution.
At the same time, taking a proactive approach in selecting investors who provide the necessary expertise and strategic support also helps ensure a good fit and the continued success of the business in the future.
Choose the Right Funding
Choosing appropriate funding sources is crucial for controlling equity dilution. Founders need to decide between different alternatives, such as equity, venture debt, or revenue-based financing, that are compatible with their company’s stage, requirements, and goals. A suitable option not only enables you to get the required funds but also minimizes the loss of your stake in the company.
Be Aware of Your Valuation and Plan for Dilution
Before setting out to raise capital, a good, independent, and realistic assessment of your business is crucial. By knowing the value of your company, you can determine how much stock to issue and establish clear expectations between you and the investors. A strong valuation enables you to negotiate with confidence and avoid giving away too much of the company.
To make this process easier, Cheqly has collaborated with Eqvista to help you get reliable valuation reports that show your startup’s growth and help you make informed decisions based on data when seeking investment
Limit Use of Convertible Securities
Convertible notes, SAFEs, and warrants offer the advantage of quick fundraising, but they can cause additional dilution when converted into shares. Restricting their amounts to match your immediate conversion plans helps protect your ownership stake.
Optimize Employee Equity Compensation
Equity offers are an effective way to attract and retain high-quality employees; however, they can also lead to dilution of ownership. Employing smaller grants on a more regular basis can motivate workers and, at the same time, reduce dilution.
Explore Alternative Financing Options
Founders generally hold most of their equity when raising money, especially in early-stage or well-structured financing rounds. However, as more funding rounds occur, founder ownership can be significantly diluted. Nonetheless, revenue-based financing or venture debt are examples of alternative options that can provide funding with less equity dilution.
Focus on Your Core Business
If you want to keep more of your equity, you will need a solid business plan and realistic financial projections. These help investors take you seriously and give you more leverage when negotiating. A strong pitch can even bring in more than one investor, which means better terms, possibly more funding, and less dilution for you.
Manage Cash Carefully
Keep an eye on your company’s burn rate and cash reserves. Efficient cash management can be instrumental in extending your fundraising timeline, which means that you will not have to get capital at low valuations and dilute your ownership unnecessarily.
Seek Expert Financial Advice
Get advice from financial advisors who can walk you through different funding scenarios and help you build a strategy that fits your goals. Their expertise can make a big difference in helping you make smart, confident decisions.
Minimize Dilution, Maximize Control
As a company expands, equity dilution is bound to happen. Still, it doesn’t always mean losing influence or future value. Founders who plan carefully and time their fundraising well can preserve a larger share while getting the capital they need.
One of the most efficient methods to reduce dilution is by exploring funding avenues that do not cause dilution, such as venture debt. Cheqly, for example, offers venture debt funding—allowing venture-backed startups to access capital without issuing new shares.
At the end of the day, getting funds should align with your goals, not go against your control of the company. With suitable approaches and collaborators, you have a chance to safeguard your stake as well as your business’s future.
Are you ready to retain a larger share of your business as it grows? Find out if you qualify for venture debt and explore additional opportunities for expansion.