Founders' Guide to Modeling Equity Dilution Across Multiple Funding Rounds

Founders' Guide to How Equity Dilution Works in Startup Funding Rounds

Your current cap table feels solid. It’s a clean spreadsheet showing exactly who owns what. But that snapshot is a poor guide for the future. As you prepare to raise capital, understanding how does equity dilution work in startup funding rounds becomes a critical competency, not an academic exercise. The compounding effects of post-money SAFEs, option pool expansions, and investor preferences can erode your personal stake far more than a simple calculation might suggest. For founders in the UK and USA, navigating these mechanics without a dedicated finance team is daunting. The goal isn’t to build a model worthy of a Wall Street bank. It’s to build a forecast in a simple spreadsheet that is good enough to prevent surprises, strengthen your negotiating position, and avoid costly last-minute cap table clean-ups before a deal closes.

From Static Cap Table to Dynamic Dilution Model

A capitalization table, or cap table, is a static record of your company's ownership at a single point in time. It lists shareholders, the number of shares they hold, and their corresponding ownership percentage. It’s the official ledger. For British companies, if you allot shares you must file an SH01 return at Companies House. A dilution model, however, is a dynamic forecast. It takes your current cap table and projects how ownership will change after a series of future events, most notably a new funding round.

This distinction is crucial because a simple cap table hides future dilution. It doesn’t show the impact of an unissued employee option pool, the conversion of SAFEs or convertible notes, or the new shares to be issued to an incoming investor. Relying solely on your current cap table for founder ownership percentage forecasting is why so many founders are shocked by their final stake. The reality for most pre-seed to Series B startups is more pragmatic: a well-structured spreadsheet is all you need for effective cap table scenario planning. This model becomes your tool for running different fundraising scenarios and understanding the true cost of capital.

Stage 1: The Seed Round and the Post-Money SAFE Surprise

For many early-stage companies, particularly in the US, the first external capital comes via a post-money SAFE (Simple Agreement for Future Equity). Its appeal is its simplicity, but its mechanics can be deceptive. A post-money SAFE guarantees an investor a specific percentage of the company after their investment. This guarantee is what creates cascading dilution when you raise from multiple investors on similar terms before a priced round.

A post-money SAFE guarantees an investor a specific percentage of the company after their investment (e.g., $1M on a $10M post-money valuation buys them 10%).

Consider a SaaS startup with 10,000,000 founder shares. You decide to raise capital in two stages before your Series A:

1. First SAFE: You raise $500,000 on a $10 million post-money valuation. The investor is guaranteed 5% of the company ($500k / $10M) at the time of conversion.
2. Second SAFE: Six months later, you raise another $500,000 on an identical $10 million post-money SAFE from a different investor. This second investor is also guaranteed 5%.

A common mistake is to assume these two investors will collectively own 10% and the founders will own 90%. In practice, each SAFE’s ownership is calculated independently. The founders are diluted by the first SAFE, and then both the founders and the first SAFE investor are diluted by the second SAFE upon conversion. The founders end up bearing a larger share of the total dilution than anticipated. This is a fundamental driver of investor share dilution and a primary reason why a dynamic equity round forecasting model is necessary. For background, see Carta's guide to pre-money vs post-money SAFEs.

Stage 2: The Series A 'Shuffle' and How Equity Dilution Works in a Priced Round

The Series A round is where the theoretical ownership from SAFEs becomes real and several dilutive events happen in a specific order. Misunderstanding this sequence is where many spreadsheet models fail. This is the Series A 'shuffle'.

In a priced round, the typical sequence of events is: 1. Option pool top-up (diluting existing shareholders based on pre-money valuation), 2. Conversion of all convertible instruments (SAFEs, notes), 3. New investment money comes in.

Let's walk through an example for a deeptech startup raising a Series A. Imagine the company starts with 10,000,000 founder shares and has raised money on SAFEs that will convert. The terms of the new round are a $10M pre-money valuation, a $3M new investment, and a requirement for a 10% unallocated option pool post-investment.

1. Starting Point: The founders hold 10,000,000 shares, representing 100% of the company before the financing events begin.
2. Step 1: Option Pool Top-Up. Based on the pre-money valuation, 1,111,111 new shares are created for the option pool. This action dilutes the founders, whose stake drops to 90% of the new total of 11,111,111 shares.
3. Step 2: SAFEs Convert. The convertible SAFE notes now convert into equity. In this scenario, they convert into another 1,111,111 shares. This dilutes both the founders and the newly created option pool. The total share count rises to 12,222,222, and the founders' ownership is now 81.8%.
4. Step 3: New Money In. Finally, the Series A investor's $3M investment is made, purchasing 3,000,000 new shares. This dilutes all existing shareholders: founders, the option pool, and the SAFE investors. The final share count is 15,222,222.

After this precise sequence, the founder ownership percentage drops from 100% to 65.5%. A scenario we repeatedly see is founders incorrectly calculating this, leading to misaligned expectations during negotiations. Furthermore, the new shares issued are different. Series A shares are typically 'preferred stock,' not common stock. Preferred stock carries special economic rights. A common term, which can differ slightly between UK and US deals, is the liquidation preference. For instance, a standard preference for a Series A round is '1x non-participating'.

A standard preference for a Series A round is '1x non-participating'.

This means in an exit, the Series A investors can either take their original investment back (the '1x') or convert to common stock and share in the proceeds, whichever is more valuable for them.

Stage 3: The Series B and the Growing Preference Stack

A Series B round mechanically resembles a Series A: there is likely another option pool top-up and new money comes in, causing further dilution. However, the economic impact is amplified by the creation of a 'preference stack'. This stack determines the order in which investors get paid in a liquidation event, such as a sale of the company. The key rule is seniority.

In a liquidation preference stack, later-round investors (e.g., Series B) typically have seniority and are paid back before earlier-round investors (e.g., Series A).

This creates a multi-layered waterfall for distributing proceeds that significantly impacts what founders and common stockholders receive. To understand the post-money valuation impact, you must run a waterfall analysis. Imagine an e-commerce company that raised a $5M Series A and a $15M Series B, and is now being acquired for $75M.

1. Payout #1 (Series B): The Series B investors, with their senior preference, get their $15M investment back first. The remaining proceeds are now $60M.
2. Payout #2 (Series A): The Series A investors get their $5M investment back next. The remaining proceeds are now $55M.
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The final $55M is distributed pro-rata among all common stockholders. This includes founders, employees, and any preferred investors who choose to convert their shares to participate in this upside.

The practical consequence tends to be that a founder's 'paper' ownership percentage doesn't directly translate to their share of the exit proceeds until these preferences are cleared. This is the critical distinction between percentage ownership and the actual payout.

Practical Steps for Building Your 'Good Enough' Model

Inaccurate dilution forecasts can derail negotiations and trigger costly clean-ups. However, building a predictive model doesn't require sophisticated software or a CFO, a stage most biotech and deeptech startups have not yet reached. A spreadsheet in Excel or Google Sheets is perfectly sufficient for robust cap table scenario planning. If you outgrow spreadsheets, you can compare cap table software options. What founders find actually works is focusing on a few key components.

Step 1: Establish Your Baseline

Your model needs three primary inputs to accurately reflect your current state.

• The Current Cap Table: List every shareholder and the exact number of shares they own. Percentages should be outputs calculated from share counts, not hardcoded inputs. This is your foundation.
• All Convertible Instruments: Detail every SAFE and convertible note with its valuation cap and any discounts. These are your future liabilities that will become equity.
• Vested and Unvested Options: Track the current state of your employee option pool. Note how many options have been granted and what portion has vested. This is crucial for understanding the true overhang.

Step 2: Define Your Next Round Assumptions

This is where your startup equity calculator becomes a forecasting tool. Define the key variables for your next round, including:

• Pre-money Valuation: The value of your company before any new capital comes in.
• New Investment Amount: The total capital you plan to raise in the round.
• Option Pool Target: The size of the new or refreshed employee option pool required by new investors, usually expressed as a post-money percentage.

Step 3: Model the 'Shuffle' and Run Scenarios

With these inputs, you can model the sequence for your Series A or B by executing the steps in the correct order: option pool expansion, conversions, and new money. The power of this model lies in its ability to analyze shareholding changes over time. Adjust the pre-money valuation or the investment size and see how your founder ownership percentage changes. This simple, dynamic view of your equity is one of the most powerful tools you have to make informed fundraising decisions.

Frequently Asked Questions

Q: How much dilution is normal for a founder in a Series A round?
A: It varies widely, but founders often see their collective ownership diluted by 20% to 30% in a typical Series A round. This includes dilution from the new investor's capital, the conversion of previous notes or SAFEs, and the expansion of the employee option pool.

Q: What is the difference between pre-money and post-money SAFEs?
A: A pre-money SAFE converts based on the pre-money valuation, meaning the SAFE holder's ownership is diluted by all other SAFEs converting alongside them. A post-money SAFE guarantees the investor a fixed percentage of the company after their investment, protecting them from dilution by other SAFE investors.

Q: Why is the option pool increased before the new investment?
A: New investors typically want the option pool created or topped up based on the pre-money valuation. This ensures that the dilutive effect of issuing new employee options is borne by the existing shareholders (primarily founders), not the new investors coming into the round.

Q: Can I use accounting software like QuickBooks or Xero to model dilution?
A: No, accounting software like QuickBooks or Xero is designed to track financial operations, not equity ownership. A dedicated spreadsheet or specialized cap table software is necessary for accurate equity round forecasting and understanding how does equity dilution work in startup funding rounds.

Continue at the Cap Table Basics hub.