The dilution analysis: Understanding changes in ownership

Dilution is one of the most important - and misunderstood - parts of building a venture-backed business. Each round reshapes ownership, often more than people expect.

At its core, dilution is simple: when new shares are issued, existing shareholders own a smaller percentage of the company in exchange for new value being added.

In practice, the goal isn’t to avoid dilution, but to manage it effectively, as owning a smaller percentage of a significantly more valuable company is often the intended outcome.

The real complexity when managing dilution comes from how dilution multiplies over time - that’s why modelling ownership across multiple rounds is key.

A founder may be issuing 20% at a time each round, and then only by Series B+ would they realise their ownership has reduced to 20%, despite each round feeling reasonable at the time.

That’s because dilution multiplies - it’s rarely a one-off event, it’s a sequence that must be considered as a whole in order to understand the entire picture, and make informed and strategic decisions.

How dilution actually works

To understand dilution, it can be easier to look directly at how share issuance affects ownership.

Let’s say you’re building a company and that company starts out with 1,000 shares. You would own 100% of the company, so have all 1,000/1,000 shares.

Now, you raise investment and issue 250 new shares to an investor. You still have all 1,000 shares, but now that is 1,000/1,250 total shares in the company.

• Total shares now = 1,250
• You own 1,000
• Your new ownership = 1,000 / 1,250 = 80%

You haven’t lost shares, the percentage you own of the total number of shares has decreased because the number of total shares has increased.

Let’s take a look at what this means in numerical terms:

Before investment, you may own 100% of the company, with 1,000 shares worth £100,000. If:

• You receive £100,000 in investments, and
• You issue 20% of your company to investors

You’ll then own 80% of your company, with shares now valued at £160,000.

This clearly demonstrates that a smaller % ownership can result in a much higher monetary value. However, it’s still important to ensure that you are planning your dilution so you are able to balance ownership, control, and value.

The same principle applies across every funding round, option grant, and convertible instrument. Each time new shares are created, whether for investors, or employees, everyone else’s percentage ownership decreases unless they also receive additional shares.

This is why dilution can feel invisible, but slowly reduce your ownership stake over time. Your slice of the pie stays the same, but the pie itself keeps expanding.

The multiplying effect of dilution

Importantly, each round of dilution applies to your current ownership, not your original stake, so each step sets a new baseline for the next.

It can be easy to view dilution as a series of isolated incidents, and only account for the immediate dilution that happens after the next funding round. In reality, dilution compounds over time, and that compounding effect is what catches most founders off guard.

Each new share issuance dilutes your current cap table, not your original stake in the company, so every new dilution builds on the last.

For example:

If a founder decides to allocate 20% in their pre-seed round, their total ownership stake reduces to 80%. In the following seed round, they may wish to allocate a further 25%, reducing their total stake to 60%. In Series A, another 20% may be given away, further reducing their stake to 48%.

Three funding rounds, and now the founder owns less than 50% of the company. At each stage, the percentage loss felt manageable, but now those decisions have unexpectedly left the founder with a smaller ownership stake than expected.

This is why dilution is often underestimated - founders often think in terms of individual rounds, whilst investors and experienced operators think in terms of the full journey.

The difference between modelling one round and modelling three or four rounds ahead can completely change how much ownership you expect to retain.

Understanding the trajectory of ownership early allows founders to make more informed decisions about how much to raise, when to raise it, and what level of ownership they are ultimately working towards.

It’s also important to note that whilst the overall ownership stake decreases, each round is designed to significantly add value to the business, so a lower overall % may equate to a significantly larger outcome.

Option pools: The secret driver of founder dilution

An option pool is a portion of shares set aside for employees, within which share option schemes (such as EMI) are used to attract and retain top talent. This allows founders and investors to ensure there is enough equity available to build a strong team.

In most rounds, it’s advisable to set up an option pool prior to raising investment. This is an investor-friendly approach that signals thoughtful cap table planning, strong foresight, and founder quality.

It’s also typically preferred by investors, as it gives them a clearer view of their eventual ownership from the outset.

The dilutive impact options pools have is on current shareholders, as it’s absorbed by members of the existing cap table in exchange for the team growth.

For example - a founder may issue 20% to an investor in a single round, but also set up a 15% option pool for future hires. The founder ownership post-investment would sit at 68%, rather than the pre-planned 80%.

Option pools also aren’t a one-off event. As the company grows, the pool may need to be refreshed in future rounds to continue hiring. Each refresh introduces further dilution, which would likely affect existing shareholders.

Option pool size should be carefully thought out in order to minimise unexpected dilution. The founders who manage dilution best are the ones who treat option pools not as an afterthought, but as a core part of their ownership strategy.

What ‘fully diluted’ really means

Fully diluted is the lens through which most investors will view your cap table. It represents the total number of shares that would exist if all potential shares were issued. That includes not just current shareholders, but also option pools and convertible instruments.

This matters because it reflects the true ownership structure of the company. If you only look at issued shares, it would be easy to overestimate your ownership.

Fully diluted figures provide a more realistic picture of where ownership will sit once all equity commitments are issued fully.

It’s also a key communication tool - founders, investors, and employees need to understand not just current ownership, but how that ownership will evolve over time.

How institutional investment can affect ownership and control

As businesses move into institutional rounds, dilution is no longer just about the percentage ownership - it becomes intertwined with control too.

It’s common for investors to negotiate board seats for larger investments, meaning that even if founders retain a large majority shareholding of the business, they may not have complete control over key decisions.

Alongside this, investors may also negotiate provisional rights or preferential shares that give them veto rights over major actions such as issuing new shares.

There are also economic rights to consider: liquidation preferences, for example, can affect how funds are distributed in an exit, meaning that the isolated ownership percentage doesn’t always reflect actual financial outcomes.

In this context, dilution is not just a mathematical concept - it directly affects governance, control, and the company structure itself.

Why issuing more shares early can be strategic

Although it may seem counterintuitive, planning for higher initial dilution can be a strategic decision.

It creates a greater level of flexibility and control over founder dilution. It allows companies to allocate equity for employees, investors, and future rounds without needing to constantly restructure the cap table and having to revisit or analyse dilution retrospectively - when it’s too late.

Having a larger option pool set up before investment also allows you to take account of the dilution needed to scale your team upfront, so investors brought onto the cap table post-option pool creation are not continually diluted.

This maintains a positive founder-investor relationship, builds trust and credibility, and provides room to scale without unexpected reductions in ownership.

Secondaries: Selling existing shares

A secondary transaction is when existing shares are sold, rather than new ones being created. That usually means a founder, early employee, or early investor sells part of their stake to another investor.

Importantly, no new shares are issued in a secondary. The total number of shares in the company stays the same, so:

• There is no dilution to other shareholders
• Ownership simply moves from one shareholder to another

As the market evolves, market frameworks such as PISCES (Private Intermittent Securities and Capital Exchange System) are growing to support more structured secondary trading in private companies, helping improve access to liquidity over time.

Why secondaries happen

In early-stage startups, founders and employees are often fully locked into their equity, sometimes for years. As companies take longer to reach an exit, secondaries can provide a way to see some value earlier without needing to sell the business.

For early employees, it can be a way to access liquidity without waiting for an acquisition, which could take years until they can benefit financially from their commitment to the business.

Why investors can be cautious about secondary sales

Despite the benefits, secondary sales are not always viewed in a positive light, particularly for earlier-stage businesses.

One of the main concerns is signal - if a founder is selling a large proportion of their shares early on, it can raise questions about their long-term commitment to the company’s future.

Questions are also raised around incentives - employees and founders are incentivised by the promise of a larger future exit, so if too much value is seen too early, the goal alignment can weaken.

How founders can stay in control

Founders can’t avoid dilution, but they can shape how it plans out as their company grows. The most effective approach is to treat dilution as something to be expected, modelled, and managed. It doesn’t have to be a byproduct of growing a business, but can be direct, intentional, and accounted for.

That means understanding how different valuations affect outcomes, planning option pools carefully, and being deliberate about how much capital is raised at each stage.

Equally important is understanding that ownership and control are not the same thing. Whilst there’s overlap between their functions, maintaining influence over the direction of the company requires attention to governance as well as equity.

Dilution is not always negative, it is the mechanism through which companies bring in capital, talent, and expertise to grow.

The real question is not how to avoid dilution, but how to ensure that it happens on the right terms, at the right time, and in a way that supports long-term value and scalability.

Issue shares with Vestd

With Vestd, you can issue shares to investors, model ownership scenarios, build custom share schemes, and manage your digital cap table, all in one place.

With two-way Companies House integration, everything stays accurate and up to date. You can also use the shared ownership calculator to see how your stake could change after an investment round, helping you plan dilution with confidence.

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