The pulse of the startup ecosystem never slows down and neither should you! Keep mastering important legal terms with our newsletter. Today, we're diving into a subject that's often discussed and even more often misunderstood: equity dilution.
What’s equity dilution?
Equity dilution happens when a company issues new shares. This often happens in connection with investment rounds. As a result, existing shareholders' ownership percentage goes down. Simply put, if you have 10 % with 100 shares and the company issues 100 more shares, your ownership drops to 5 %.
Why does equity dilution matter?
Understanding equity dilution is important for both the existing shareholders and the new investors. Here's why:
Ownership impact: Existing shareholders’ slice gets smaller. It affects their voting power and returns.
Valuation: It needs to be fair for everyone, old and new shareholders alike.
Employees: Dilution can impact the size of the ESOP pool. It’s standard to top up the ESOP pool whenever a new round happens.
Dos and don'ts
Here are our top tips and mistakes to avoid backed by years of experience.
plan ahead and understand the effect of dilution
clearly communicate the impact to all stakeholders
ensure fair company valuation
don't forget the impact on ESOP
don't surprise shareholders
In a nutshell
Equity dilution isn't good or bad: it's a fact of life. When handled well, it can be leveraged for success. But when underestimated, it can cause trouble. Importantly, unless there’s a downround, the value of shareholders’ shares actually increases despite dilution.
Got a question about equity dilution or need guidance in an upcoming investment round? We're here to help. Feel free to reach out through our website. Follow us on LinkedIn and stay tuned for next newsletter!
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