Antidilution has been the topic of a prior post and is kind of a tough topic.  I find I have to go over the concepts carefully with entrepreneurs. Some entrepreneurs tend to think of dilution as purely a matter of percentage ownership. Although ownership dilution is important particularly as it relates to voting control, investors are typically more concerned with financial dilution. Financial and ownership dilution are related but different concepts. Ownership dilution is easy to explain, if Easy Company has 1,000,000 shares issued and outstanding in the hands of stockholders, and you own 500,000 of these, you own 50% of Easy Company. If Easy Company then sells another 1,000,000 shares to a new investor, there will be 2,000,000 shares outstanding and you will still own 500,000, but now you only own 25% of the company. That is ownership dilution. 

Financial dilution is a little more complicated to explain. Using the same example, if Easy Company had 1,000,000 shares outstanding and sold 500,000 to you for $1.00, you would own half of the company and your shares would be worth $1.00 each or $500,000.  If time passes and Easy Company raises an additional $1,000,000 at $2.00 per share it would issue 500,000 new shares to new investors. As a result, there would be 1,500,000 shares outstanding of which you would own 500,000 or one third. So, you would have ownership dilution (you went from one half to one third). However, the company would have a valuation of $3,000,000 ($2.00 multiplied by the number of shares outstanding after the new financing). The value of your shares would have increased – not been diluted.

Suppose, however, that Easy Company raised $1,000,000 by selling shares at $.50 per share. It would then issue 2,000,000 new shares to new investors and the total number of outstanding shares would go from 1,000,000 to 3,000,000. The value of the company would be $1,500,000, and the value of each share would be $.50. In this example, your 500,000 shares now represents approximately 16.67% of the company (down from 50%) so you have suffered ownership dilution, and your shares are now worth $.50 each (down from $1.00) so you have suffered financial dilution.

The antidilution formulas that are a customary part of venture investments, are aimed at protecting the investor from financial dilution. How the typical formula works will be the topic of another blog entry, but for a very detailed analysis, see my article on the subject of antidilution.