Dilution

Three people starting a company usually begin by deciding how to slice 100 percent. Write down 40, 30, 30 and it feels settled. Then the first investment conversation happens, someone says "we'll give you 20 percent," and the arithmetic stops working. The three already add up to 100, so where does the 20 come from?

The answer is that nothing is carved out — new shares are printed. Miss that and the conversation keeps going in circles. Shares the company gives an investor are not taken from existing shareholders and handed over; they are shares that did not exist before. The founders' share count doesn't drop by one. Only the percentage does.

That is why the situation needed its own name. It isn't being taken from, and it isn't selling, and without a word for the third thing you end up explaining it from scratch each time. The same event repeats through every round after Series A — the round a company raises to scale a model it has already validated — and every line in the table moves down together each time.

An ownership percentage is your share count divided by the total share count, and dilution is what happens when the numerator holds still and the denominator grows.

In a company with 100 shares, someone holding 20 owns 20 percent. Issue 25 new shares so the total becomes 125, and those same 20 shares now represent 16 percent. That isn't 4 percentage points shaved off — it's the original stake reduced to four fifths of itself.

How much dilution occurs is set by two numbers in the deal.

1. Pre-money — what the company is valued at before the investment arrives.
2. Post-money — pre-money plus the amount being invested.

The investor's percentage is the investment divided by the post-money valuation. Raise $1.5 million on a $6 million pre-money and the post-money is $7.5 million, so the investor holds 20 percent. Existing shareholders as a group go from 100 percent to 80 percent, which takes a founder at 40 percent down to 32 percent.

One more item attaches here. An option pool is equity set aside in advance for people the company has yet to hire, and investment agreements often place that pool inside the pre-money valuation. Create a new 10 percent pool and absorb it before the money lands, and the only people diluted are the existing shareholders. The same $1.5 million round now takes the founder to 28.8 percent instead of 32 percent. Negotiations split on this line more often than on the valuation itself.

A smaller percentage is not the same as being worse off. Forty percent of a $3 million company is $1.2 million; 32 percent of a $7.5 million company is $2.4 million. The percentage fell 8 points and the amount doubled. It's the question of whether half of one pizza beats a third of three. So the number worth tracking through a round isn't the percentage on its own but the percentage paired with the valuation behind it.

This isn't a concept that stays in a spreadsheet. It settles real terms in fundraising and in hiring, and it turns up in three places.

1. Weighing a term sheet. Model the next two rounds, not just this one. At roughly 20 percent dilution per round, a founder at 40 percent lands at 32 percent, then 25.6 percent, then 20.5 percent. That's how you see where giving up an extra 5 points today arrives three years out. Founders who skip the exercise tend to discover the answer at the round where control is already gone.
2. Raising at a lower price. A down round is an investment at a lower valuation than the previous one, and because the denominator is smaller, the same amount of money dilutes far more. If an existing investor's anti-dilution protection fires at the same time, their share of that dilution shifts onto founders and employees.
3. Hiring. A stock option is the right to buy shares at a set price, and a candidate offered 0.5 percent who assumes it will still be 0.5 percent three years in is working from the wrong number. Two rounds later it's 0.32 percent, and nothing unfair has happened — that is simply what two rounds do to every line in the table. Saying so at offer time works out better than explaining it afterward.

"How much does this round dilute our side?"

Start with the terms and calculate how far existing shareholders drop.

"Putting the option pool in the pre-money means we're the only ones carrying that 10 percent."

The same headline valuation, with considerably more actual dilution behind it.

"We got diluted, but the valuation doubled, so our piece is worth more."

Read the amount, not the percentage.

Pagedeck built this calculation into a table for the first time while raising its Series A. The day Grace brought the terms back, what the company checked wasn't one line of valuation but three: the investor's percentage, the size of the new option pool, and who carries that pool.

The third line is where negotiation dragged. Putting the pool in the pre-money versus the post-money moved the founders' stake by more than 3 percentage points, which mattered more than getting the valuation raised by $400,000. Pagedeck has looked at those three lines together on every term sheet since.

The most common mistake is reading dilution as having equity taken away. Only the falling number is visible, so the reaction is natural. But a percentage is one half of a fraction whose other half keeps changing, and what anyone actually holds is that percentage multiplied by the company's value. Get diluted while the value rises and the amount grows. Miss that distinction and a team delays a round it needs in order to avoid dilution, then raises on much worse terms once cash runs short.

Assuming the percentage tells you your payout is just as common. The table prints a percentage, so it looks that way. But when a company sells, the order in which money goes out is set by the contract, not by the cap table. A liquidation preference is an investor's right to recover money first when the company is wound up or sold: in a $15 million sale where investors take $11 million off the top, only the remaining $4 million gets split by percentage. Watch the diluted percentage and skip that line and the math comes out badly wrong.