Dilution Solutions

Dilution Solutions

Insight from Carta

Finally, let’s cover the not-so-fun side of financing: dilution.

Everyone remembers that endlessly meme-able scene from The Social Network, right?

Let’s talk about why Andrew Garfield was pissed off.

Dilution occurs after a round of funding, an increase to your employee stock pool, or post IPO. 

When shares are granted to new investors, they aren’t taken from the existing pool, they’re created… ✨magically ✨.

Everyone keeps the same number of shares they had before, but each share now represents a smaller percentage of the whole pool. 

Just like that, the value of each share goes down (see the below image for an example).

Remember when I told you above that VC's usually require you to set aside an option pool for employees before they'll invest? 

Dilution is the reason. 

Once you issue their shares, even if you do more fundraising later on, the dilution doesn't affect them, only the previous shareholders 😬

So, how can we set ourselves (and, more importantly, our teams) up for success and mitigate future dilution? Here are a few paths:

• Don’t raise more than you need. Early money is more dilutive, so raising more than you need in the early stages will dilute every other shareholder MUCH more than in later rounds.

• Don’t create a bigger option pool than you need. We gave the figure of 10-20% early on, which is a good benchmark. An even better idea is constructing a well-thought-out hiring plan that forecasts exactly what amount of equity you plan to set aside so that you don’t overshoot.

• Read the fine print. The fundraising landscape has shifted a lot more in favor of investors. It’s worth investing in some sort of modeling tool to really chart out exactly what the future holds.

Make sure you understand exactly how you and your team will be diluted before taking on financing.

You’ll save yourself a headache, and maybe a busted laptop too (sorry Zuck!)

Learn more: Everything you need to know about share dilution and how to mitigate it