Equity Dilution in Funding Rounds

Understanding dilution is critically important for any entrepreneur who plans on raising venture capital money to help grow their startup. Learn these basics of dilution before you start raising money.

Equity dilution is the curse of the startup executive. If you don't understand how equity dilution works, you can find yourself working very hard.for very little.

Full-ratchet? Weighted ratchet? Down rounds? If it sounds like we're talking a foreign language, then you're not familiar with the concept of antidilution clauses -- and you should be if you're thinking about pursuing investment opportunities with venture capitalists.

Dilutive funding rounds (or down rounds) are a source of frustration for a company's existing investors. In many cases, their frustration boils over into a lawsuit. Before it gets to that point, there are a few ways to mitigate the risks of legal challenges surrounding investor equity dilution.

If you have to give antidilution protection to investors, make sure you only give antidilution protection to investors who are willing to continue to invest in your company. A 'pay-to-play provision is the best way to ensure that antidilution clauses are not helping investors who won't stick around for subsequent rounds.

You've invested in a startup, but now a new round of financing will dilute your percentage ownership in the company. Is that good news or bad news? It depends on whether it's an up round or a down round. If it's an up round, you've got little reason to be unhappy.

Founders find a down round of financing to be depressing because their ownership stake in their company dwindles. For founders, there are some solutions to this challenge that may need to be addressed with your investors.