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Start-up Financing & Equity: What is Dilution?

Written by: David M. Adler

Article Overview: Equity dilution reapportions a stockholder’s percentage of equity (stock) in a company. Here’s a scenario to demonstrate how equity dilution works.

Start-up Financing & Equity: What is Dilution?

Let's begin with 1,000,000 issued and outstanding shares prior to the company receiving equity investment financing. Let’s say you own a five percent (5%) stake. For our example, let’s assume that the new investors will get a thirty five (35%) equity stake. Since, in all likelihood, the investors are getting shares from the Company and not existing stockholders, the company needs to issue new shares. The next question is, how many shares?

The answer is computed using simple algebra. If (x) is the number of new shares that need to be issued, the equation is: x / (1,000,000 + x) = .35. In this hypothetical, x = 538,461.5. Since there are no half shares we round up to 538,462 new shares that must be issued to the investors. So, now the total number of shares in the company is 1,538,462. What is your percentage equity stake in the company?

Since you owned five percent (5%) prior to the financing, that’s 50,000 shares. After the financing, you still have 50,000 shares. However, your percentage of ownership has been diluted by the new stockholders. Your diluted equity stake in the company is 50,000/1,538,462, or 3.25%.

©David M. Adler, All Rights Reserved
David M. Adler, Esq. & Associates, PC
Safeguarding Ideas, Relationships & Talent®

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Article Tags: adler, algebra, equity investment, equity stake, investors, likelihood, outstanding shares, relationships, stockholders



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