How does dilution work in startups?
Dilution can be one of the most overlooked aspects of the startup journey. Especially in the early stages of fundraising.
Yet, it can also be one of the most impactful factors for startups, their founders, and everyone they touch later on.
So, how does dilution work in startups? What are the real pros and cons of allowing dilution?
How should you be thinking about it when you are fundraising?
What smart alternatives can there be for fueling your venture with all of the resources it needs, without diluting your company?
What Is Dilution In Startups?
The concept of dilution is quite simple. It refers to the strength or concentration of your ownership in the company.
Specifically, the value or the percentage of the company your shares of ownership represent can become diluted when you issue more of them.
For example, if you began with 100 shares of your company, which you all personally held as the founding CEO, you have 100% of the company.
Now, if you issue 100 more equal shares, your 100 shares have been diluted to only represent 50% of the company, and all of the rights that come with them.
The more shares that are issued, and more owners there are, the more diluted your ownership becomes.
Do not underestimate the influence of dilution in your startup. In some cases, the trade-off is more than worth it. If not essential for reaching your goals.
In other cases, the dilutionary effects of fundraising and other compensation trends can sabotage your vision and what is most important to you on this journey.
Keep in mind that in fundraising storytelling is everything. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
How Dilution Happens In A Startup
There are a variety of ways that dilution happens in a startup.
Yet, they all really come back down to the number of shares the company has issued, who holds them, and how many owners or stockholders there are.
Common scenarios which result in dilution include the following.
Company Formation With Multiple Partners
Your original amount of stock and the value of those shares will typically mostly depend on how many founding partners there are.
If you are a solo founder you may begin with fewer shares and have 100% of the company.
Or you may form your company with four or eight other co-founders who split up the company evenly.
The more you have, the more dilution risk there is, and potentially more issues you can have later.
Or you may have silent partners who put in capital and give you full reign to run the company as you see fit.
Equity Options/Options Pools
When you are raising money for your startup, it can be common for investors to have you set aside a pool of shares for attracting employees and executive talent.
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