To dilute something is to make it less concentrated, and so it is with the ownership of your business. When you set up a company it’s all yours and you own all the shares – 100% of them. Then an investor comes along and wants a share of your business in exchange for some money. Your company issues some new shares and sells them in exchange for the investment.
Let’s say you set up your business with 100 shares and they’re all yours. Then investor A comes along and you agree to receive their investment and in return they will get a 20% share holding. So you issue 25 more (new) shares taking the total share pool to 125. Your new investor takes those 25 shares and becomes a 20% (25/125) shareholder. You still have your original 100 shares, and now have 80% of the business (100/125). You’ve been diluted.
This dilution will happen each time you take an investment and progressively you’ll end up with less.
Another investor B comes along and would like their 20%. This time your company issues 31 (and a bit) new shares bringing the total share pool to 156. They take those 31 shares and become a 20% shareholder (31/156). Both you and investor A get diluted – you to 64% (100/156) and them to 16% (25/156). You’ve got another 15% left before you slip below 50% and you lose control.
The final Cap Table shows how this might look. You hold 64% of the equity and your investors hold 36%. The next investment round might see you drop below 50%.
There have been times when new investors have asked me for upwards of 30% of my business. It sounds OK, but let it happen twice and I’ve lost control. The other shareholders, collectively, can vote me out. I might not consider that likely today, but wait until we hit rougher times and the shareholders decide to gang up.
The Dragon's Den percentages are great for TV, but not for reality. Equity is very, very precious. Fight to keep as much as you can.
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