Definition of Dilution
Dilution refers to the reduction in existing shareholders’ ownership percentage when a company issues new shares. When equity is sold to raise capital, the total number of shares increases, causing each existing shareholder’s percentage of ownership to decrease.
How Dilution Works
Dilution occurs when a company raises equity by issuing new stock to investors. Although existing shareholders still own the same number of shares, those shares represent a smaller percentage of the company because the overall share count has increased.
Dilution Explained for a General Audience
For a general audience, dilution is like slicing a pie into more pieces. If you originally owned half the pie and then new slices are created for someone else, your slice becomes smaller. You still own your slice, but it represents a smaller portion of the whole.
Dilution in Startup Fundraising
Founders often start owning most or all of a company. With each funding round, new investors receive shares, and founders’ ownership percentages decrease unless they invest additional capital. This is a normal part of raising equity but must be managed carefully.
Dilution and Company Value
Dilution does not necessarily mean a loss in value. Ideally, raising capital increases the overall value of the company, so even a smaller ownership percentage may be worth more in absolute terms. The key question is whether the investment grows the “pie” enough to justify giving up ownership.
Dilution and Control
Ownership percentage often determines voting power and control. As founders become diluted, they may lose decision-making influence, board control, or veto rights. This makes dilution an important strategic consideration beyond pure financial outcomes.
Cap Tables and Option Pool Dilution
Dilution is tracked through capitalization tables, which show ownership across funding rounds. Employee stock option pools also cause dilution, as shares are set aside for future hires, reducing ownership percentages for all shareholders.
Why Founders Try to Minimize Dilution
Excessive dilution can significantly reduce founders’ eventual payout and control. Many founders aim to minimize dilution by raising capital only when necessary or by delaying equity rounds until the company’s valuation improves.
Dilution in Ratio’s Context
Ratio positions its financing solutions as non-dilutive alternatives to equity financing. By providing capital through revenue or contract-based financing, Ratio allows companies to raise growth capital without issuing new shares, preserving founder and investor ownership.
Dilution as a Strategic Trade-Off
Every equity financing decision involves weighing capital needs against ownership loss. Founders often compare the cost of dilution today with the potential value of holding more equity later if the company grows faster or reaches key milestones.
Why Dilution Matters in a Glossary Context
Including dilution in a glossary explains a fundamental concept for anyone involved in startups, investing, or equity compensation. Understanding dilution is essential for evaluating fundraising decisions and long-term outcomes.
Summary
Dilution reduces ownership percentages when new shares are issued, typically during equity fundraising. While it is a natural part of growing a company, managing dilution is critical to preserving control and long-term value. Non-dilutive financing options, like those offered by Ratio, help companies grow while keeping ownership intact.
