Dilution — The Dollar Dictionary

Ads end in 20 seconds

Loading location...

This content is free thanks to our sponsors

Sponsored Ad – I may earn a commission if you click and buy

Next ad in 5s

You are about to visit an external website.

This is an affiliate link, and we may earn a commission.

Continue?

Finance

Dilution

The reduction in existing shareholders' ownership percentage and earnings per share that occurs when a company issues new shares.

Dilution occurs in several ways: new share issuances (to raise capital or pay for acquisitions), stock option exercises (when employees exercise options, new shares are created), convertible note conversions (debt converting into equity), and rights offerings (existing shareholders offered new shares at a discount). Each new share issued spreads the same total company value across more shares.

Anti-dilution provisions in investor agreements protect early investors from excessive dilution. Full ratchet protection (the most aggressive) adjusts early investors' share price to match any lower-priced future round — meaning in a down round, early investors get significantly more shares at the existing shareholders' expense. Weighted average anti-dilution (more common and more balanced) provides partial protection based on the size of the new round.

Think of a pizza cut into 8 slices — you own 2 slices, which is 25%. Now the pizza is recut into 12 slices. You still have the same 2 physical slices, but now you own only 16.7% of the pizza. The pizza didn't get smaller — you just got a smaller percentage of it. That's dilution.

Real world: When a startup raises a Series A round by issuing new shares to venture capitalists, the founders' percentage ownership decreases. A founder who owned 60% before the round might own 45% after. But if the company's total value grew from $5 million to $20 million in the same round, the founder's 45% stake is worth $9 million — far more than their 60% stake was worth before. Dilution in percentage doesn't always mean loss in value.

💡 Dilution reduces ownership percentage — but if the company grows in value faster than dilution occurs, shareholders still come out ahead. The key question is always whether the new capital is being used to create more value than the ownership percentage surrendered.

← Back to The Dollar Dictionary