What is dilution?

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Hey folks, I hope everybody had a great week! In this episode of The Unsophisticated Investor we’re going to speak about dilution and the effects it can have on your shareholding.

If you’ve bought shares in a promising VC backed startup that’s growing fast, you might expect to hear the company is raising more money around 12 to 24 months later. Great news, right? Well, yes and no. While fresh capital can accelerate growth, it leads to a phenomenon called dilution, and it typically has a direct impact on the shares you own.

Dilution occurs when a company creates additional shares, usually to raise investment. Let’s say you own 10% of a company. If the company raises a fresh round of funding and doubles its total shares, and you don’t buy any of the new ones, your portion of ownership could drop to 5%. You still hold the same number of shares, but your overall percentage shrinks.

Private companies often raise funds in multiple rounds. Each round might involve bringing on new investors, typically venture capital firms or angel investors, who contribute capital in exchange for equity. The additional capital is used to help a company attract top talent, develop new products or expand into new markets. While new fundraising rounds and the dilution that can come with it can reduce the fraction of the company you hold, it generally boosts the company’s overall value. So, if the company grows, your shareholding (albeit a smaller slice) could end up being part of a much bigger pie.

A very basic example:

You invest €5,000 in a startup called GreenTech Innovations during its seed round. Each share costs €1, so you receive 5,000 shares. At this point, the total number of shares in GreenTech is 500,000, meaning your 5,000 shares represent 1% ownership of the company.

Seed round snapshot:

• Your investment: €5,000

• Your shares: 5,000

• Total company shares (post-seed): 500,000

• Your ownership: 1%

A year later, GreenTech is gaining momentum and needs more capital. They raise €1,000,000 at a higher share price of €2. This new money comes from professional investors who get 500,000 newly minted shares in exchange for their funding. Now, the total number of shares in GreenTech jumps to 1,000,000 (the original 500,000 plus the new 500,000).

Because you choose not to buy more shares at this stage, you still have 5,000 shares. However, your stake has been reduced from 1% to 0.5% (5,000 out of 1,000,000). That’s the dilution effect, your piece of the pie just got slimmer.

Post Series A investment:

• Your investment remains: €5,000

• Your shares remain: 5,000

• Total company shares: 1,000,000

• Your ownership: 0.5%

Dilution usually isn’t a bad thing because it generally means the company is growing quickly and increasing in value. Despite owning a smaller percentage, those 5,000 shares will now be more valuable. With the share price at €2, your stake is worth €10,000, effectively doubling on paper, assuming the company’s fundamentals are strong and the new capital accelerates growth.

Dilution is neither good nor bad, it’s simply an unavoidable fact of life that every investor, whether institutional or individual, has to deal with. Inevitable as it may be, understanding how dilution works is really important. When you know exactly why your percentage ownership changes and what that means for your holding, you’ll be better equipped to make confident and informed decisions about your investments.

What we’ve been working on at Shuttle

• We’re mid private launch with customers investing right now 🚀

• Today we’re shipping the new Shuttle portfolio page showcasing all our past investments 📦

• We added a new section to the Shuttle homepage showing visitors the VC firms we’ve co-invested with 🤝

• Added a number of minor tweaks to improve the overall investment flow 💪

The Unsophisticated Investor is brought to you by Scott & Rob, the founders of Shuttle. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. Shuttle’s singular focus is to unlock private markets for Millennial and Gen Z tech professionals and help them build wealth through the highest performing private market opportunities.

Scott & Rob
Shuttle Co-Founders