What is dilution math?
Dilution math is the calculation that quantifies how a new equity issuance reduces the ownership percentage of existing shareholders. Every venture funding round dilutes founders, employees, and prior investors as new shares are issued to incoming investors. Understanding the pre-money/post-money relationship, option pool expansion timing, and the impact of convertible instruments is essential for both founders defending equity and investors structuring optimal terms.
Core formulas
- Post-money valuation = Pre-money valuation + Investment amount
- New investor ownership % = Investment / Post-money valuation
- Founder dilution % = Investment / Post-money (in the simplest no-pool case)
- Price per share (PPS) = Pre-money / Fully diluted pre-money share count
- New shares issued = Investment / PPS
Pre-money vs. post-money option pool
- Pre-money pool (“shuffle”): option pool top-up included in pre-money — dilutes founders only. Investor-favourable; common in US.
- Post-money pool: option pool created post-financing — dilutes everyone proportionally. Founder-favourable; harder to negotiate.
- Effective valuation: with a 10% pre-money pool top-up on a $10M pre-money/$10M raise deal, founders’ effective pre-money is closer to $9M than $10M.
Convertible instruments and SAFE conversion
- SAFE/note conversion at qualified financing: uses valuation cap or discount to determine conversion price; converts before priced round shares are issued.
- Stacking dilution: multiple SAFEs at different caps all converting at the same financing compound dilution unexpectedly.
- YC pro-rata side letter: some SAFEs include MFN or pro-rata rights affecting downstream dilution.
A worked example — and the option-pool shuffle
The mechanics are simple but unforgiving. If a startup raises 2 million on a 8 million pre-money valuation, the post-money is 10 million and the investor owns 20% (2/10). Existing holders are diluted pro rata across the remaining 80%. The trap that catches many founders is the option-pool shuffle: investors often require a new or enlarged option pool to be created before the money goes in — that is, inside the pre-money. Because it sits pre-money, the entire dilution from that pool is borne by the founders and existing shareholders, not the new investor, even though the pool exists to hire future employees who benefit everyone. Modelling the pool as pre- versus post-money can move a founder’s stake by several percentage points, which is why the cap-table model, not just the headline valuation, decides how good a term sheet really is.