All companies need capital to finance their growth. Startups often need to grow so fast that their own revenue would not be enough to finance all the investments required for that growth. That’s why startups need external capital.
The capital needed for growth will likely come from equity or financing rounds. A financing round is, for example, when an investor is willing to provide 1M€ for 10% of the company. To give the investor 10% of the company, new shares are created. If there were previously 900,000 shares, 100,000 more are created so that the investor now owns 10% of 1,000,000 shares.
The consequences of financing rounds
The company value and employee share price are likely to increase, although dilution is incurred in percentage terms.
The new investment not only brings capital into the company but also improves its growth potential and chances of success. All stakeholders benefit from this. It could, for example, be that the company was previously valued at 3M€ and is now valued at 10M€ (1M€ investment for 10%) so the share price has more than tripled.
So what is dilution?
If an employee previously held 1000 shares, they owned 0.11% of the 900,000 shares. Now they still hold 1000 shares, but as there are more shares, they own 0.10% of the 1M shares. However, these shares are worth triple what they were before.
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