How Does Dilution Work

Transcript:

One over one equals to one hundred percent, one over ten is equal to ten percent one over one hundred is one percent dilution happens as the number of sales held by a person stays the same while the total number of the outstanding shares (the denominator) grows. If you bring investors in or others onto your company’s cap chart, dilution is unavoidable.

An important distinction and point of confusion is the difference between authorized shares versus issued/outstanding shares.

Authorized shares often two million, five million, ten million is the max a company can issue before changing the charter to create more but the number of issued/outstanding shares makes up the denominator for calculating ownership percentages on an ongoing basis.

This represents ownership on a fully-diluted, as-converted basis, so securities like convertible notes, warrants and options would also count.

Take a look through the charts below for an example of how a holder’s ownership percentage shrinks as others are added to the cap chart but the value of those shares usually increases.

Keep dilution in mind when allocating equity. When you offer equity, communicate that they will get a certain number of shares or units of the company. That number might equal to a certain percentage today, but they won’t necessarily own that same percentage forever.

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