Dilution is the decrease of ownership that happens if new investors buy equity/shares in your startup.
The current valuation of your startup is USD 4m. A business angel decides to invest USD 1m to bring the company to the next level. After transferring USD 1m onto your bank account the valuation of your startup increases from USD 4m to USD 5m. The business angel now owns 20% of the company (USD 1m / USD 5m = 20%), and the existing shareholders are “diluted” from 100% ownership to 80% ownership.
How important is it for founders to keep the majority?
Not important – at least not if you want to build a tech unicorn. The founders will get diluted and lose the majority over time in almost all cases (and if you have co-founders you don’t have it from the very beginning). The saying “better own 1% of McDonalds than 100% of the burger place next door” has a lot of truth to it.
You may try to keep the saying in your company via special voting rights, even if you don’t own 50% of the shares anymore. After all, Facebook, Snap and other prominent tech companies did this. But similar as we expect clean terms from investors we want to offer them clean terms from our side. So we advice against this: As long as founders are doing a good job the investors will want them to keep rocking.
How much dilution is acceptable in a given financing round?
As described in detail in Phase 2, we strongly advice to not give away more than 25% in a given financing round.
Having said this, there are cases where 30% (or even more) can be acceptable or even attractive. But be aware of the downsides in case you need several more financing rounds: The founders will not own enough shares in the company anymore – which poses a risk that they leave the company, and which is a red flag for potential future investors.