Understanding Dilution

​

What is Dilution?

Dilution occurs when the percentage ownership of existing shareholders, including the token owner, decreases as new shares are issued during a fundraising round. While the absolute number of shares owned remains the same, each share represents a smaller percentage of the total token.

​

How Dilution Works

With each funding round, ownership percentages shift as new shares are issued and the total number of outstanding shares increases.

​

Basic Example

Let’s say your personal token has these characteristics:

• Total shares: 10 million
• Your ownership: 9 million shares (90%)
• Investor ownership: 1 million shares (10%)

If you decide to raise more capital by selling an additional 1 million new shares:

• New total shares: 11 million
• Your ownership: 9 million ÷ 11 million = 81.8% (down from 90%)
• Original investor ownership: 1 million ÷ 11 million = 9.1% (down from 10%)
• New investor ownership: 1 million ÷ 11 million = 9.1%

​

Detailed Dilution Scenario

Here’s a more comprehensive example showing multiple rounds:

​

Investor Protections Against Dilution

To protect early investors who take the highest risk, the Network provides several anti-dilution mechanisms:

​

1. Pro Rata Rights

Existing shareholders have the right (but not obligation) to participate in future funding rounds to maintain their ownership percentage.

Example: If an investor owns 5% and you’re raising a new round, they can invest enough to maintain their 5% ownership after the round closes.

​

2. Information Rights

• 7-day minimum notice before any fundraising round
• Shareholders receive details about:
  • Number of shares being sold
  • Price per share
  • Round timeline
  • How to exercise pro rata rights

​

3. Anti-Dilution Provisions

Protection against “down rounds” where you raise capital at a lower valuation than previous rounds.

How it works:

• If you previously sold shares at $2 each
• But now need to sell at $1 each (down round)
• The Network automatically adjusts early investors’ share allocations
• Similar to weighted-average anti-dilution in traditional VC

​

Strategic Considerations

​

For Token Owners

Benefits of accepting dilution:

• Access to capital for growth and investments
• Bringing on strategic investors with valuable networks
• Sharing risk with aligned partners
• Potential for higher absolute returns even with lower percentage

Managing dilution:

• Price rounds appropriately to minimize unnecessary dilution
• Choose investors who add strategic value beyond capital
• Consider the long-term impact of each round
• Maintain control through board composition and voting rights

​

For Investors

Understanding your protection:

• Pro rata rights help you avoid dilution in future rounds
• Information rights ensure you’re informed about opportunities
• Anti-dilution provisions protect against down rounds
• Secondary market provides liquidity options

​

Dilution vs. Value Creation

It’s important to understand that dilution isn’t inherently bad if it leads to value creation:

​

Positive Scenario

• You raise $1M by selling 10% of your token
• Use that capital to make investments that generate 50% returns
• Your 90% ownership of a more valuable token may be worth more than your previous 100%

​

Example Calculation

• Before: 100% of $5M token =$5M value
• After: 90% of $8M token =$7.2M value
• Result: Despite dilution, your value increased by $2.2M

​

Best Practices

​

Planning Your Rounds

1. Model different scenarios before setting terms
2. Consider long-term dilution across multiple rounds
3. Price rounds fairly but don’t undervalue yourself
4. Communicate clearly with existing investors

​

Managing Investor Expectations

1. Be transparent about future fundraising plans
2. Explain your growth strategy and capital needs
3. Give adequate notice for pro rata participation
4. Maintain regular communication about progress

​

Tools and Resources

The Network provides several tools to help manage dilution:

• Cap table management - Real-time ownership tracking
• Dilution modeling - Scenario planning for future rounds
• Pro rata calculators - Help investors understand their rights
• Automatic notifications - Ensure compliance with information rights