How Does Dilution Work?
The term dilution refers to the ownership percentage of a share of stock in a company declining over time due to the issuance of additional equity/shares in a company.
For example, lets say that GoingPlaces Corp. is raising capital. Before raising new funds, the company has 100,000 shares outstanding; so each share represents a 0.001% ownership in the company. Let's also assume the company has a pre-money valuation of $5 million (i.e. shares are worth $50 each)
If GoingPlaces raises $2 million at the existing valuation of $5 million, 40,000 new shares will need to be issued. After the transaction, the company will have a post-money valuation of $7 million ($5m pre-money valuation + $2m in cash), and have 140,000 shares outstanding with an estimated value of $50 each.
Post transaction, the ownership percentage of each share of stock declined (i.e. dilution). Pre-transaction, 100,000 shares existed and each share represented 0.001% ownership; post-transaction 140,000 shares exist and each share represents 0.000714% ownership. As you can tell by the example, the dollar value of each share did not decline. But due to the issuance of new shares, the percentage ownership of the company each share represents decreased (e.g. was diluted) due to the issuance/"sale" of new shares to the investor.
Note that this scenarios is overly simplistic for illustrative purposes. VC investors frequently invest in preferred shares versus common shares, which have preferential attributes to them and are in nearly all circumstances more valuable than common shares. Additionally, the example does not take into account existing stock option grants, which would effect the overall share count (known as fully diluted share count).
Article Last Updated: April 18, 2025