Dilution refers to the decrease in ownership percentage of existing shareholders in a company when new equity is issued. This typically occurs when a company raises capital or establishes stock option pools, resulting in the issuance of additional shares. As a consequence, the ownership stake of existing shareholders is diluted. Dilution can impact various aspects of a stock, including voting control, earnings per share, and the value of individual shares.

In early-stage equity financing, dilution is a common occurrence as startups go through multiple funding rounds to fuel their growth. The timing of investment plays a significant role, as earlier investors are more likely to experience higher levels of dilution. Factors contributing to dilution include the issuance of new shares to investors in subsequent funding rounds, the expansion of stock option pools for employees, and the conversion of convertible securities like convertible notes or simple agreements for future equity (SAFEs). Understanding these dilutive events and their effects is essential for investors to make informed decisions and protect their investment interests.

While dilution may initially seem undesirable, it is often a necessary step for companies seeking to raise capital and expand their operations, which often coincides with valuation growth. Investors experiencing dilution often end up owning a smaller, yet more valuable piece of a bigger pie. Additional funding can lead to an increase in the company's valuation, which may benefit shareholders in the long term.