What is Equity Dilution?
Equity dilution occurs when a company issues new shares, reducing existing shareholders' ownership percentage. Every funding round, employee stock option grant, and convertible note conversion dilutes founders' stakes. Understanding dilution is critical for founders to maintain meaningful ownership and ensure their financial outcome aligns with years of effort.
The Formula
Post-Dilution Ownership = Pre-Round Ownership × (Pre-Money Valuation ÷ Post-Money Valuation) Post-Money Valuation = Pre-Money Valuation + Investment Amount
Option pool increases (typically 10-20% for a round) also dilute founders and are often negotiated as part of the pre-money valuation.
Worked Example
A founder owns 80% of a company. They raise a $2M Seed round at an $8M pre-money valuation with a 10% option pool refresh.
- Post-money valuation = $8M + $2M = $10M
- Investor ownership = $2M ÷ $10M = 20%
- Option pool = 10% (from pre-money, so existing shareholders bear this)
- Founder dilution: 80% × (1 − 0.20 − 0.10) = 80% × 0.70 = 56%
📌 The founder's stake drops from 80% to ~56% after the Seed round. After Series A and B, a typical founder retains 20-30% of the company.
Why This Matters
Founder financial outcome
A founder with 25% of a $100M exit makes $25M. A founder with 8% makes $8M. Every funding round dilutes, so raising at higher valuations or with less capital preserves more ownership.
Control and governance
Below 50% ownership, founders lose board control. Below certain thresholds, protective provisions give investors veto power over key decisions including future fundraising, M&A, and executive hiring.
Employee equity pool planning
Understanding dilution helps you plan option pools that attract talent without excessively diluting founders. Top-up pools of 5-10% per round are typical.
Common Mistakes
❌ Ignoring the option pool shuffle
VCs often require a 15-20% option pool be created from the pre-money valuation. This means founders bear the dilution, not the new investors. A $10M pre-money with 15% pool is effectively a $8.5M pre-money.
❌ Not modeling multiple rounds
Seed dilution looks manageable at 20%. But Seed + A + B + option pools can leave founders with 15-25%. Model your full dilution path before accepting terms.
❌ Raising too much too early
Raising $5M at a $10M valuation gives away 33%. The same company raising $2M at $10M gives away only 17%. Take only what you need at early stages when valuations are lowest.
Industry Benchmarks
| Category | Good | Average | Poor |
|---|---|---|---|
| Seed Round Dilution | 10-15% | 15-25% | Above 30% |
| Series A Dilution | 15-20% | 20-30% | Above 35% |
| Founder Ownership at Exit | 20-30% | 10-20% | Below 10% |
Source: PitchBook 2024 Annual US Venture Capital Report
Benchmark data sourced from PitchBook 2024 Annual US Venture Capital Report.