What is dilution and how does it affect founders?
Written by For Founders Law, a Toronto firm licensed by the Law Society of Ontario. About us
Short answer
Dilution is the drop in your ownership percentage when the company issues new shares, for example to investors, employees or SAFE holders when their SAFEs convert. You keep the same number of shares, but they're a smaller slice of a larger company. Dilution isn't bad in itself if the money or people it brings in make the company worth more.
How does dilution work?
When new shares are issued, every existing shareholder’s percentage drops. Say two founders each hold 5,000,000 shares, 50% each. An investor buys 2,500,000 new shares. There are now 12,500,000 shares, and each founder owns 40%.
| Before | After investment | |
|---|---|---|
| Founder A | 5,000,000 (50%) | 5,000,000 (40%) |
| Founder B | 5,000,000 (50%) | 5,000,000 (40%) |
| Investor | none | 2,500,000 (20%) |
| Total | 10,000,000 | 12,500,000 |
If the investor paid $1 a share, the company’s post-money value is $12.5 million, and each founder’s 40% is worth more than their 50% was before. That’s the trade.
What causes dilution?
- Priced rounds, when investors buy new shares. See when do I need a priced round?
- SAFE and note conversions, when convertible money becomes shares. The valuation cap and discount decide how many.
- Option pools, which reserve shares for employees. If investors ask for the pool to be created before their money comes in, founders bear all of it. See what is an option pool shuffle?
- Advisor and employee grants. See can I give shares to an advisor?
Why do SAFEs make dilution hard to see?
Because SAFE holders don’t own shares until conversion. Several SAFEs with different caps can add up to more dilution than founders expect. A post-money SAFE fixes each holder’s ownership percentage against the company’s capitalization before the priced round, so founders absorb the dilution from each additional SAFE. See post-money vs pre-money SAFE. Model every SAFE on your cap table before signing the next one.
Can I protect myself from dilution?
Not entirely; growth usually needs new shares. But some terms limit it:
- Pre-emptive rights. If the articles provide for them, shareholders have the right to buy their proportion of new shares of their class before others, under section 28 of the CBCA or section 26 of the OBCA. Investors often get a contractual version, called pro rata rights.
- Anti-dilution protection. Preferred shares often adjust their conversion price if the company later sells shares at a lower price. That protects investors and shifts dilution to founders and other common holders, so read the formula carefully.
- Negotiating the pool size based on a real hiring plan.
Is there a normal amount of dilution per round?
It varies with the market, the amount raised and the valuation, and we don’t publish a rule of thumb. What matters is modelling your own numbers before you sign, including every outstanding SAFE and the option pool.
Our SAFE round work starts at $2,600 and includes the SAFE agreement, board approval, the prospectus exemption review and the securities filing for the round. Fees are in Canadian dollars and exclude HST; securities regulator filing fees and other disbursements are charged at cost. See fees.
This guide is general information about Ontario and Canadian law, not legal or financial advice for your situation. To model a round before you sign, book a free 15-minute consult.