If you’ve ever dealt in venture funds, you’d know dilution is one of the critical reasons why you need to update a cap table. It occurs when someone invests in a company, and their equity share decreases as the shares increase. This happens because there are more shares now than before, so each share has less equity.
If you’ve ever wanted to calculate the dilution shares of your start-up’s shareholders to improve your venture finances, this post can serve as your guide.
What Is Dilution?
Dilution is an essential concept in finance, where it can be used to calculate the value of a company’s shares. And as mentioned, dilution occurs when new shares are issued by the company, which reduces the percentage share that existing shareholders have. This can happen, for example, when a company issues new shares to raise capital or when shareholders buy new shares from those who have sold them.
The dilution in a cap table is shown by how many shares a shareholder has and how many claims they had before. But to achieve the metric, you’ll need to measure it through an online calculator or manual computation.
What Is A Cap Table?
A cap table is an essential document for any company. It shows what kind of equity each person or stockholder has in the business. It also shows how many shares each person or entity owns and what percentage they hold relative to the total shares. It also provides information about how many shares are authorised, issued, and outstanding.
There are three forms of cap tables:
- The flat equity-based cap table lists all shareholders in order of their ownership percentage.
- The weighted equity-based cap table lists shareholders in proportion to their ownership percentage.
- The debt-based cap table lists shareholders in order of the amount they have loaned to the company.
More so, the dilution in a cap table is shown by how many shares a shareholder has and how many claims they had before. But to achieve this, you’ll need to measure it through an online calculator or manual computation.
Calculating Dilution In A Cap Table
Dilution in a cap table can be measured in two ways: percentage and ratio. In both ways, you can decide to use an online cap table calculator or not.
Furthermore, here are things to know about measuring dilution:
- Percentage Dilution
Percentage dilution can be calculated by dividing the number of the originally issued shares by the number of total shares that have been diluted.
For example, if your company has 1,000 shares and you own 500 shares, then this means that you own 50% of the company. And to get funding, perhaps you and your business partner have decided to issue another 1,000 shares. With this, your percentage ownership will drop to 25%.
- Ratio Dilution
The dilution ratio can be calculated using common and preferred stocks, warrants, and convertible securities. The dilution ratio for common stock is calculated by dividing the number of new shares issued by total common shares outstanding, which will give you a percentage representing how much diluted your ownership stake has become.
Based on the previous example, with the additional 500 shares on top of the current 1,000 shares, your and your partner’s ownership has been diluted by 50%.
- Using A Calculator
Dilution can be calculated using a dilution calculator. The dilution calculator will show you what percentage of ownership you have after any given event.
When calculating ownership percentages, it’s essential to include the shares issued by the corporation and not just the total number of shares. For example, if a company issues 150 shares and you own 5% of the company, your actual ownership percentage would be 5 / (150 + 5) = 0.0075%.
Benefits Of Measuring Dilution In A Cap Table
It’s crucial to measure dilution to ensure that the company’s equity remains intact. The benefits of measuring dilution in a cap table are:
- Ensuring that equity is not diluted
- Forecasting the company’s future potential growth
- Comparing companies using similar metrics
- The ability to compare the ownership percentage of different shareholders in a cap table
- Knowing what percentage of ownership someone has
- Understanding how much money each shareholder should receive
- Assessing the risk involved with issuing new shares
- Determining if there are any actions to take based on the dilution measurement
Conclusion
In any venture, dilution cannot always be avoided. As such, understanding what it is and how it works can help you recognise when there’s a risk of dilution and make an informed decision about how to proceed. You can measure it through manual computation, or perhaps, use an online calculator to save you time.
