Understanding Cap Table Dilution Before Your Series A
Every new funding round dilutes existing shareholders. Understanding the mechanics helps you negotiate better terms and avoid surprises on your cap table.
Dilution is the reduction in existing shareholders' ownership percentage when new shares are issued. It's not inherently bad — you're trading ownership for capital — but understanding the mechanics is critical before signing a term sheet.
Pre-Money vs Post-Money Valuation
If an investor offers a $2M investment at a $8M pre-money valuation, the post-money valuation is $10M. The investor owns 20%, and your existing shares are worth more in absolute terms — even though they represent a smaller percentage.
The ESOP Pool Problem
Many term sheets include an option pool refresh requiring you to create or expand an ESOP before the investment closes. This pool is typically carved out of the pre-money valuation, meaning founders bear the dilution, not the incoming investor.
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