What is Dilution?

/ March 18, 2019/ Valuation & Fundraising

As a founder, you’re likely to hear the term “dilution” at some point. But what is dilution?

Capshare’s Startup Guide to Equity Dilution explains key dilution concepts. Early Growth Financial Services lists 7 strategies to help founders maintain equity.

Dilution Concepts

Dilution means a decrease in your ownership stake of your company. There are two types:

1. Narrow — Ownership decreases because new equity shares are issued. Existing shares are now a smaller percentage of total shares.

2. Broad or General — Anything that causes existing shares to be less valuable. Examples include liquidation preferences, convertible debt, creation of an option pool, etc.

Strategies to Maintain Ownership

Why would a company want to give away ownership? Well, that’s often the price paid to raise growth capital. It makes sense to give away a slice of the pie if your remaining slice will be of a much bigger pie.

With that being said, strategies exist to help founders retain as much ownership as possible:

1. Raise money to reach definite milestones. Raising money just to have cash in the bank is not a good way to maximize ownership.

2. Look at alternative means of financing (e.g., bootstrapping, MRR line of credit, SBA loans, etc.). VC money usually involves the most dilution. Loans and lines of credit will involve cash costs such as interest; however, it may be worth it in the long run if you can keep a higher ownership stake.

3. Build traction. Traction refers to building strong business fundamentals like a good product, a growing customer base, etc. A business with traction has more leverage when it comes to negotiating terms for capital raises.

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