What Dilution Really Means
Dilution is the reduction in your ownership percentage when a company issues new shares. It is important to understand that dilution reduces your percentage, not necessarily your value. Owning 40 percent of a company worth Rs 100 crore is worth far more than owning 100 percent of a company worth Rs 2 crore. Founders who fear dilution instinctively often make worse decisions than founders who model it deliberately.
The Core Math
Every dilution calculation reduces to one idea. When new shares are issued, your existing shares stay the same in number but become a smaller slice of a larger pie. If an investor buys a stake equal to a fraction of the post round company, every existing shareholder is scaled down by the same factor. For example, when an investor takes 20 percent of the company in a round, everyone who held shares before that round is multiplied by 0.8, because together they now share the remaining 80 percent.
A Worked Example: Seed to Series B
Assume two founders start out owning 100 percent between them. Here is how a clean sequence of rounds might play out.
- Seed round. The founders create a 10 percent ESOP pool and sell 20 percent to a seed investor. After the round the split is founders 70 percent, seed investor 20 percent, ESOP pool 10 percent.
- Series A. A Series A investor buys 25 percent of the company. Every existing holder is scaled by 0.75. Founders drop from 70 percent to 52.5 percent, the seed investor from 20 percent to 15 percent, and the pool from 10 percent to 7.5 percent, with the Series A investor holding the new 25 percent.
- Series B. A Series B investor buys 15 percent. Every existing holder is scaled by 0.85. Founders go from 52.5 percent to about 44.6 percent, the seed investor to 12.75 percent, the pool to about 6.4 percent, Series A to 21.25 percent, and Series B holds 15 percent.
The founders journey, from 100 percent to 70 percent to 52.5 percent to roughly 44.6 percent, is completely normal. Across a healthy financing path, founders commonly give up somewhere in the range of 15 to 25 percent of the company in each priced round.
The Pre-Money ESOP Pool Effect
Here is the subtlety that catches most founders. Investors almost always insist that a new or expanded option pool be created in the pre-money, that is, before their money goes in. This is sometimes called the option pool shuffle, and it matters because it decides who pays for the pool.
Return to the seed round. The 10 percent pool was carved out of the pre-money, so the founders absorbed all of it. Compare that with an alternative where the investor first takes 20 percent, leaving founders at 80 percent, and only then a 10 percent pool is created out of everyone. In that alternative the pool would dilute the investor too, and the numbers would settle near founders 72 percent and investor 18 percent instead of founders 70 percent and investor 20 percent. The gap looks small, but it is a direct transfer of ownership from the founders to the investor, dressed up as a pool.
Two practical lessons follow. First, a larger pre-money pool lowers your effective pre-money valuation, because you are giving up more of the company for the same cheque. Second, size the pool to the hiring you actually plan before the next round, not to a round number an investor suggests, because every unused percentage sitting in a pre-money pool is dilution the founders funded for no reason.
Model Before You Sign
Before agreeing to any term sheet, build the full post round cap table, including the pool, and look at both your resulting percentage and its rupee value. Dilution is not something that simply happens to you. It is something you negotiate, and the founders who model it round by round keep far more of what they build.