In venture capital funding, dilution refers to the reduction in the ownership percentage of existing shareholders as a result of issuing new shares of stock. Dilution can occur when a startup raises new capital by issuing new shares of stock, such as through a follow-on round of financing.
When a startup raises new capital, the company will typically issue new shares of stock to the investors in exchange for their investment. This increases the number of shares outstanding, which in turn reduces the percentage of ownership held by each existing shareholder. This reduction in percentage ownership is known as dilution.
Dilution can also occur when a startup issues new shares of stock to employees or other stakeholders, such as through stock options or equity grants.
Dilution can have a negative impact on existing shareholders, as it reduces the value of their ownership stake in the company. However, dilution is often necessary for startups to raise the capital they need to grow and develop their business.
It's important for startups to consider dilution when raising new capital, and also to strike a balance between raising the necessary capital and minimizing dilution as much as possible. This can be done by issuing fewer shares, issuing shares at a higher price, or by using structures like convertible notes or SAFE notes which convert into equity at a later date.