Founder dilution: understand it, calculate it, plan for it

What is dilution, and why is it not necessarily a loss?

When a company issues new shares, the total number of shares goes up. Each existing shareholder keeps the same number of shares, but they now represent a smaller percentage of the equity.

If the round happens at a higher valuation than the previous one, the diluted stake can be worth more in euros than before: owning a smaller slice of a bigger company is still a good outcome.

Dilution does have two concrete effects to watch, though: the share of the proceeds of any future sale that goes to the founders, and their weight in shareholder votes.

How do you calculate dilution after a round?

The rule is simple: after the round, each existing shareholder’s stake equals their stake before the round multiplied by the ratio between the pre-money and the post-money valuation.

The calculation gets more complicated as soon as there are instruments that will later turn into shares, such as BSPCE (French employee stock options) or BSA AIR (a French convertible instrument). That is why people often work on a so-called fully diluted basis, which assumes all of these rights are exercised or converted.

In France, shareholders have a pre-emptive subscription right on cash capital increases, in proportion to the shares they hold, which they can waive individually (Commercial Code, article L225-132). Warrants and convertible instruments such as BSA or BSA AIR are securities giving access to capital (article L228-91) and must be counted in the fully diluted calculation.

Which operations dilute the founders?

Creating a BSPCE pool deserves particular attention: investors often ask for it to be set up before they come in, which means it dilutes only the existing shareholders. That is a negotiation point in its own right.

A BSA AIR does not dilute anyone when it is signed, but its conversion at the next round adds to that round’s dilution, so include it in your models from the outset.

What are anti-dilution clauses?

Anti-dilution clauses protect an investor if the company later raises money at a lower valuation than the one they paid. They generally entitle the investor to extra shares to make up for part of the drop.

• The weighted average formula takes into account the price and the size of the new issue, so the adjustment is usually moderate.
• The so-called full ratchet formula brings the investor’s price down to the new price, whatever the size of the new issue, and is much harsher on the founders.
• The protection can be limited in time, restricted to certain rounds or made conditional on the investor taking part in the new round.

These clauses are negotiated in the term sheet and then written into the shareholders’ agreement. They only come into play if the valuation falls, but their effect on the founders can then be significant.

How do you plan for dilution over several rounds?

A team that raises money several times sees its stake shrink at each round. The goal is not to avoid dilution altogether but to stay motivated enough, and in a position to decide, until the project succeeds.

1. 1Build a fully diluted cap table that includes every instrument issued.
2. 2Model several scenarios for future rounds, with cautious amounts and valuations.
3. 3Agree with your co-founders on the minimum stake the team wants to keep at each stage.
4. 4Raise what you need to reach milestones that genuinely increase value, and no more.
5. 5Use non-dilutive sources when they fit, as explained in our guide to non-dilutive funding.
6. 6Negotiate the size and timing of the BSPCE pool.

How is dilution shared between co-founders?

In a standard round, all existing shareholders are diluted in the same proportion, so the relative split between co-founders does not change. Only the team’s total stake goes down.

Differences appear when a co-founder leaves before the end of their vesting, when a shareholder reinvests in the round or when a new co-founder joins after a round, which is why the shareholders’ agreement should cover these cases.