Cap Table Simulator.

What is dilution and why is it unavoidable?

Dilution means that an existing shareholder's percentage stake decreases because new shares are issued. That happens in every financing round. A distinction has to be made between numerical dilution and economic dilution: as long as the price per share increases, the pie grows faster than the percentage stake shrinks. A founder who holds only 60% after the Series A may be economically better off than before with 100% of a much lower company value. In practice, the main question is therefore who is diluted by the new shares, and by how much: only the founders, existing investors as well, or also the ESOP pool. The term sheet should make that allocation numerically clear. Another key economic driver is the liquidation preference: it determines how exit proceeds are actually distributed and can materially shift the economic value of any ownership percentage.

Pre-money vs. post-money

Pre-money is the value before the fresh cash comes in; post-money is the value afterwards. Often, however, an investor requires the employee participation pool to be increased to a target size before investing. That increase (the ESOP top-up) raises the share count before the new round and lowers the implied price per share. As a result, part of the dilution is borne by the existing shareholders even though the headline valuation may look unchanged. Convertibles/CLAs make the picture even more complex because their conversion can affect the new equity investors' percentage depending on the conversion method.

The results therefore include the final percentages, the calculated issue price per share and the economic value of the existing shareholders for each method. “Headline” means the valuation entered from the term sheet. Existing shareholder value shows which part of the pre-money basis is attributable to shareholders already participating before the round. ESOP top-ups and conversion shares included in the pre-money capitalization before the new money arrives are excluded.

ESOP post-money: 10% is more than 10%

This calculator uses “ESOP” as an umbrella term for employee participation pools, including virtual programmes (VSOP). The math is the same; the differences lie mainly in the legal and tax structure.

An ESOP target is often negotiated as a post-money percentage even though the pool is created before the round. Anyone looking only at the target percentage will underestimate how many additional shares actually have to be factored in before the new money arrives.

“10% ESOP post-money” requires materially more new shares before the round than 10% of the existing shares because the top-up dilutes itself. Mathematically, this is circular and awkward to model in Excel. Founders unfamiliar with that mechanic regularly underestimate the actual dilution effect.

Convertibles/CLAs: who bears dilution on conversion?

If convertibles/CLAs were issued before the financing round being modelled, they typically convert into shares in that round. The key question is whether those conversion shares are already included when calculating the issue price for the new round. That determines whether the dilution from converting those instruments is shared pro rata by everyone or economically borne mainly by the historic shareholders.

Everyone pro rata: the price per share is calculated by dividing the pre-money valuation by the existing shares, excluding the conversion shares. The convertibles/CLAs then convert into additional shares, and those shares dilute everyone proportionately, including the new equity investors. This model fits the view that the convertible/CLA and the equity investment should economically be treated as one combined round.

Historic shareholders only: the pre-money valuation is understood on a fully diluted basis, i.e. including the conversion shares. The new equity investors therefore pay a lower price per share that already reflects the conversion. Their percentage (investment / post-money) remains fixed; the dilution from conversion is borne exclusively by the historic shareholders. In term sheets, this variant is often signalled by wording such as “The pre-money valuation is on a fully diluted basis” or “Outstanding convertibles/CLAs are taken into account when calculating the pre-money valuation”. Caution: “fully diluted” is not used consistently in practice. The decisive question is whether the conversion shares are included in the share count for calculating the issue price.

Nominal amount only: the principal amount of the loan (and, where relevant, accrued interest) dilutes everyone. The pricing benefit resulting from the cap or discount, however, is borne only by the historic shareholders. The outcome sits between the other two variants and can be used as a negotiated hybrid solution.

Pre-money cap vs. post-money cap

A pre-money cap limits the conversion price by reference to the capitalization before conversion. If additional convertibles/CLAs or SAFEs are issued before the equity round, they can still change the eventual percentage of an individual convertible/CLA holder. A post-money cap reverses that logic: the cap is post the convertible/CLA or SAFE money, but pre the new money in the equity round. If the cap actually applies, the holder's percentage before the equity round can be approximated as conversion amount divided by post-money cap; several post-money SAFEs do not dilute each other, but they are diluted by the later equity round. Cap type controls exactly that denominator question: are the conversion shares themselves counted when calculating the cap price, or not?

Why the method is a matter of negotiation

The economic starting point is this: if the convertible/CLA is treated as its own earlier financing round, its conversion shares are typically included in the pre-money capitalization before the new equity round. The negotiated percentage of the new equity investors then remains intact; the conversion dilution is borne mainly by the historic shareholders. If, however, the instrument is closer to an advance payment into the same round, it is more coherent to treat convertible/CLA holders and new equity investors in the same dilution step. The conversion shares are then excluded from the pricing denominator; they are issued alongside the new shares and dilute the new equity investors proportionately as well. The conversion method cannot be fully fixed in the convertible/CLA agreement itself because the equity investors in the next round still have to agree to it. In practice, the method is therefore negotiated in the term sheet and the financing documents of the equity round.

Convertible/CLA vs. SAFE

In German early-stage financings, the market standard is still a convertible/CLA, typically documented as a convertible loan with interest component, cap, discount and qualified subordination. In the US startup and venture capital market, SAFEs are more common. The key structural difference: a SAFE is an equity-like instrument without maturity, interest or repayment claim. The commercial negotiation points - discount, cap and triggers - are similar; the legal classification is not.

In Germany, SAFEs are less common. Their legal qualification is not fully settled, and both the tax and accounting treatment raise questions that have not yet been conclusively resolved by higher court authority. For more detail, see our convertible/CLA article.

Keep modelling

For valuing an early-stage round backwards from the exit, use the startup valuation calculator. Exit waterfalls driven by preferences are covered by the liquidation preference calculator. Down rounds and protection mechanics can be explored in the anti-dilution calculator.