Quick Summary
Dilution occurs when a company issues new shares, reducing the ownership percentage of existing shareholders. While ownership percentage decreases, the total value may increase if the company valuation grows.
Dilution refers to the reduction in ownership percentage of existing shareholders when a company issues new shares. While dilution reduces the percentage owned, it is often acceptable if the company's valuation increases sufficiently to maintain or increase the total value of the holding.
Types of Dilution
| Type | Cause | Impact |
|---|---|---|
| Primary Dilution | New share issuance (fundraising) | Ownership % decreases |
| Secondary Dilution | Option pool expansion | Future dilution when exercised |
| Anti-Dilution | Down round protection | Adjusts earlier investor stakes |
| Full Ratchet | Extreme down round protection | Severe founder dilution |
Dilution Calculation Example
Pre-Money Valuation: ₹10 crore
Investment: ₹2 crore
Post-Money Valuation: ₹12 crore
| Shareholder | Before | After | Value (Before) | Value (After) |
|---|---|---|---|---|
| Founder | 100% | 83.3% | ₹10 Cr | ₹10 Cr |
| Investor | 0% | 16.7% | ₹0 | ₹2 Cr |
The founder's ownership percentage decreased from 100% to 83.3%, but the value remained ₹10 crore (the investment brought in new capital).
Typical Dilution Through Funding Rounds
- Seed Round: 10-20% dilution
- Series A: 15-25% dilution
- Series B: 15-25% dilution
- Series C+: 10-20% dilution
- Pre-IPO: 5-15% dilution
Anti-Dilution Provisions
Investors may have protection against down rounds:
- Full Ratchet: Earlier investor price fully adjusted to new lower price (very harsh for founders)
- Weighted Average: Partial adjustment based on amount raised at lower price
- Broad-Based: Includes all outstanding shares in calculation (more founder-friendly)
- Narrow-Based: Excludes certain shares (less founder-friendly)
Managing Dilution
- Raise capital efficiently - take only what you need
- Focus on valuation growth to offset dilution
- Negotiate anti-dilution terms carefully
- Maintain control through voting agreements
- Use debt financing when appropriate (no dilution)
- Consider alternative funding (revenue-based, grants)
Economic Dilution vs Ownership Dilution
- Ownership Dilution: Percentage of company owned decreases
- Economic Dilution: Value of holding decreases (worse)
- Up-rounds: Ownership dilutes but economic value increases
- Down-rounds: Both ownership and economic value may decrease
Key Points
- Reduction in ownership percentage
- Occurs when new shares are issued
- Acceptable if company value grows
- Typical: 15-25% per funding round
- Anti-dilution protects investors in down rounds
- Distinguish ownership dilution from value dilution