Dilution

Dilution means that the percentage ownership of existing shareholders decreases because new shares are issued. When fresh capital comes in through new shares, ownership is spread across more parties. An existing shareholder who does not participate proportionately then holds a smaller part of the company. A calculation illustrates the mechanism: if the pre-money valuation is eight million euros and a new investor puts in two million, the post-money valuation is ten million and the new investor holds 20 percent. All previous percentages fall by a fifth.

The distinction between percentage and value is decisive: dilution is economically harmless as long as valuation rises faster than the percentage falls, since a smaller share of a much more valuable company is worth more than the reverse. It becomes a problem only in a down round or where capital is raised without corresponding progress. Beyond the funding round itself, there are further sources of dilution. One is creating or increasing an option pool, often done before the round and therefore borne economically by existing shareholders alone. Others are the conversion of outstanding convertible loans and SAFEs and a triggered anti-dilution adjustment. Protection comes from pre-emption rights allowing existing shareholders to participate pro rata, and from pro-rata rights for investors.

A German GmbH can raise new equity through a capital increase resolved in notarial form. The parties must determine who subscribes for the new shares and how existing subscription rights are handled. Founders should look at dilution across several rounds rather than a single one, because the effects compound: a stake falling by a fifth per round is at roughly half its starting level after three rounds. That calculation raises the practical question of how much capital is genuinely needed, since every additional million raised permanently costs ownership. It should also be borne in mind that a sufficient founder stake is itself a criterion for later investors.