# Stock dilution during funding round?

A fictitious scenario:

Suppose a start-up has issued 100 shares. The company is valued at \$1,000. The owner has 50% of the shares, and an investor has 40% of the shares, and an employee owns the remaining 10% of the shares. Then a new investor is willing to invest \$10,000 in the company.

Question 1: Can it be said that company is now valued at \$10,000? Question 2: How does a company make room for new investors? I'm assuming it'd issue more shares. The employee would likely not be given a proportional amount of shares, so his/her ownership would go down. But what about the first investors? What is a common scenario when a series-a,b,c, etc. close?

# Edit

For the sake of my use case, let's say the new investor is not buying stock from existing shareholders, but rather, the company is issuing more stock.

## 2 Answers

Question 1: Can it be said that company is now valued at \$10,000?

This question cannot be answered without knowing what percentage of the company the new investor is getting for his \$10,000. If the new investor gets 100% of the company for \$10,000, then it can be said that the company is valued at \$10,000. On the other hand, if the investor gets 1% of the company for \$10,000, then it can be said that the company is valued at \$1 million (\$10,000 / 0.01 = \$1,000,000).

Question 2: How does a company make room for new investors?

A new investor could buy existing shares from existing owners. For example, the employee could sell his shares to the new investor. Alternatively, the company could issue new shares to the new investor. I elaborate on this in my answer to this question: Private company investment

The employee would likely not be given a proportional amount of shares, so his/her ownership would go down.

Suppose the company has 1000 outstanding shares. 500 shares (50%) are owned by the founder, 400 shares (40%) are owned by his friend, and 100 shares (10%) are owned by the employee.

• If a new investor comes along and buys 100 shares (10%) from the employee, the employee's stake will be reduced to 0%, while the founder and his friend have their percentage ownership intact.

• If the new investor comes along and the company issues 1000 new shares to the new investor, then all the existing ownership stakes will be reduced. Now, the founder still has 500 shares, but that is only 25% (500 / 2000) of the shares outstanding (which is a decline from the 50% before the sale of shares to the new investor). The friend still has 400 shares (20%), while the employee has 100 shares (5%). The new investor has 1000 shares (50%).

From your comment:

Let's say the company issues another 1,000 shares. Can the owner grant himself however many shares he/she wishes in order to maintain 50% ownership?

In this scenario, all shareholders are owners of the company. If you own shares, you are an owner. The friend is an owner, the employee is an owner. That is why I used "founder" instead. When there are other owners, it is not possible for a shareholder to grant themselves as many shares as they want without the consent of the other shareholders. Other shareholders may vote against such a proposal or take legal action to stop it from happening.

Would the company give them stock in order to maintain the investor's worth, since their original investment was diluted?

Their ownership percentage is diluted by the issuance of new shares, but that does not mean that the value of their investment is decreased. Stock dilution does not necessarily destroy value to the existing shareholders. Relevant question: Why is stock dilution legal?

• Thanks for clarifying. I get the math now. Do you know what's a typical way that this works out, say, in a series-b? I'm assuming the [FOUNDER] won't simply get an ownership cut. 1. Can the founder issue a bunch of shares to himself/herself? 2. What's typically done to the investor(s) who funded the series-A? Dec 4 '20 at 23:33
• "Can the founder issue a bunch of shares to himself/herself?" This typically requires the consent of other shareholders in one way or another. I am not familiar enough with start ups to answer your other question about series A investors.
– Flux
Dec 4 '20 at 23:44

If the investor could raise 10 000\$ cash using their stocks, wouldn't that be a viable solution too? That way, no single party would be penalized for raising liquidity.

• Although you make a good point, my arbitrary example is there just so we can put numbers on the board. What I'm trying to learn is not alternative ways to raise money, but rather, how a series-b (and subsequent funding rounds) affects issued private stock in a start-up. Dec 6 '20 at 7:36
• I don't understand your answer. Could you explain further? In particular, I don't know what you mean by "raise 10 000\$ cash using their stocks". What stocks? What do you mean by "penalized for raising liquidity"? What penalty?
– Flux
Dec 7 '20 at 9:35
• Sure Flux. Well, both the owner and major investor could request a stock loan from a loan provider which requires collateral, in the form of cash or non-cash securities (i.e. stocks), of value equal to or greater than the loaned securities. Penalized meaning they would need to give out an x% of shares to raise equity. Dec 8 '20 at 11:11
• Why would anyone be willing to provide a loan collateralized by the shares of a startup? The interest charged on such a loan must be exorbitant.
– Flux
Dec 10 '20 at 8:37