Dilution” is the decrease in Equity Ownership percentage (and potential economic value) for a company’s existing stockholders as a result of the company issuing new shares of Capital Stock. Dilution can be one of the more complex and critical terms negotiated in an Equity Financing. The impact of Dilution is one of the significant issues facing business owners and Investors as the company raises additional rounds of funding and grants Equity Compensation to key members of the team.

As background, the initial Founders start with 100% of the Equity Ownership of the company. As the company grows, the Founders may want to issue shares of Capital Stock to raise more funding, compensate consultants, or reward current employees. At each issuance, the Equity Ownership percentage of each Stockholder decreases.

To illustrate, assume that the three initial Founders have an equal Equity Ownership percentage of the company (i.e., one-third (1/3)), each owning 1,000,000 shares of Common Stock. The company closes its first round of financing and issues 1,000,000 shares of Common Stock to an Investor. As a result of the Financing, the three initial Founders no longer own 100% of the outstanding shares of Common Stock; and, after the resulting Dilution, each Founder now owns one-fourth (1/4) of the outstanding shares of  Common Stock (i.e., 1,000,000 divided by 4,000,000).