Equity Dilution in Startups: What It Does to Your Stock Options

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

Equity dilution in a startup is the drop in your ownership percentage when the company issues new shares, usually in a funding round, an option pool increase, or when SAFEs and convertible notes turn into stock. Your share count stays the same, but the total number of shares grows, so each share is a smaller slice. Dilution is not automatically a loss: if the round is priced higher than the last one, your smaller slice can be worth more on paper. It becomes a loss when the money raised does not grow the company enough, when the round is a down round, or when a large preference stack sits ahead of your common stock at the exit.

This page is for the W-2 parent who has left, or is thinking of leaving, a public-company job at Apple, Amazon, Genentech or Gilead for a venture-backed startup, and wants to know what each new round does to the grant the family is counting on. If you are still deciding whether to take the offer, value the offer first, including the RSUs you would give up (see how to calculate RSU value). This page picks up after you have the grant.

Where dilution comes from

Four events add shares to the fully diluted count (all common, all preferred on an as-converted basis, all granted options and warrants, and the unallocated pool):

• Priced funding rounds. New investors buy newly issued preferred stock. This is the dilution everyone expects.
• Option pool increases. Investors often ask the company to enlarge the pool for future hires as a condition of the round. When the increase is counted in the pre-money valuation, existing holders, including you, absorb all of it and the new investor absorbs none.
• SAFEs and convertible notes. Early money raised without a price converts into shares at the next priced round, often at a discount or under a valuation cap. Many employees never hear about these until the conversion shows up in the cap table.
• Warrants and venture debt. Lenders sometimes receive warrants to buy shares, which add to the count when exercised.

Two of these four (the pool increase and SAFE conversion) are easy to miss because they do not come with a press release.

Worked example: one grant through two rounds

Assumptions, all illustrative: a California household with $950,000 of combined W-2 income, two children ages 4 and 7. One parent leaves a biotech job for a Series A startup and receives 200,000 stock options with a $0.50 strike, all treated as vested here to keep the math simple. After the Series A, the company has 20,000,000 fully diluted shares, and Series A investors paid $2.00 per share ($10 million for 5,000,000 shares, a $40 million post-money valuation).

Series B. The company adds 2,000,000 shares to the option pool before the round, then raises $40 million at a $120 million pre-money valuation. The price is $120 million divided by 22,000,000 pre-money shares, or about $5.45. The investor receives about 7,333,333 new shares. Your ownership falls from 1.00% to 0.68%, but your paper value rises from $400,000 to about $1.09 million because the price per share went up.

Series C. Another 1,500,000 shares go into the pool, then the company raises $100 million at a $400 million pre-money valuation, about $12.97 per share. Your ownership falls to 0.52%, and the paper value is about $2.59 million.

Over two rounds you gave up almost half of your percentage (1.00% to 0.52%), and in this case that was a good trade. The pool increases alone cost you a meaningful slice: without them, your stake after Series C would be noticeably higher. That is why the pool size is worth asking about at each round.

Why the paper value is not the exit value

The table uses the preferred price, which is what investors paid for a different, senior class of stock. In this example the preferred investors have put in $150 million in total ($10 million, $40 million and $100 million), each with an assumed 1x non-participating liquidation preference. To keep the math simple, assume the whole option pool has been granted by the time of the sale, so every fully diluted share shares in the proceeds. That means each class can take its money back first, or convert to common and share pro rata, whichever pays more.

• Sale at $600 million. Every class does better by converting, so everyone shares pro rata. Your 0.52% is worth about $3.11 million before your $100,000 exercise cost and tax.
• Sale at $200 million. Series C takes its $100 million back rather than converting (20% of $200 million is only $40 million). Series B takes its $40 million back. The remaining $60 million is shared by Series A (which converts) and common. Your 200,000 shares receive about $511,000, roughly half of what 0.52% of $200 million suggests.

Dilution and preferences work together. Each round lowers your percentage and adds to the stack that gets paid ahead of you. A company that raises a lot of money needs a much larger exit for common holders to do well.

Down rounds: when dilution hits common holders hardest

In a down round the new price per share is lower than the last one. Three things tend to happen at once:

• More shares for the same money. A lower price means more new shares, so your percentage falls faster than in an up round.
• Anti-dilution protection for earlier investors. Most preferred stock carries anti-dilution terms, commonly a weighted-average formula and occasionally a full ratchet. These increase the number of common shares each preferred share converts into. Common stockholders and option holders have no such protection, so the extra dilution falls on them.
• A lower 409A value. Your options may now be underwater (the strike is above the current fair market value). Some companies reprice or issue new grants. Ask whether a repricing restarts any vesting or changes the option type.

Some rounds also include pay-to-play terms, where earlier investors who do not join the new round lose some of their preferences. That can help common holders, so read the summary the company sends rather than assuming the worst.

What you can and cannot control as an employee

Employees rarely have pro rata rights, the contractual right to buy into future rounds to keep their percentage. You cannot stop dilution. What you can do:

1. Ask for the fully diluted share count after each round. Divide your shares by it. If the company will not share it, that tells you something.
2. Ask how much went into the option pool and how much SAFE or note money converted. These are the quiet sources of dilution.
3. Ask for a refresh grant when your percentage has fallen. Many startups grant additional options to keep key people. The best time to ask is at a promotion or a new round, in writing.
4. Track the preference stack, not only the valuation. Total preferred money raised tells you the exit size at which common starts to do well.
5. Revisit the exercise decision. A higher 409A after an up round raises the spread on unexercised options, which affects the tax on exercise. Our guide to the tax on cashless exercise covers how that spread is taxed.

If the company offers employees a secondary sale, compare the offer price with your own waterfall math. See how tender offers work.

How the eventual gain is taxed in California and Washington

Dilution by itself is not a taxable event, because you have not sold anything. Tax arrives when you exercise or sell. For 2026, a qualifying long-term capital gain is taxed federally at up to 20% (above $613,700 of taxable income for married couples filing jointly), plus the 3.8% net investment income tax for joint filers with modified AGI over $250,000 (Rev. Proc. 2025-32; IRS NIIT page).

• California has no lower rate for capital gains, so the gain is taxed as ordinary income, up to 13.3% at the top under the 2025 rate schedules, the latest published (FTB). California also does not follow the 2025 federal expansion of the qualified small business stock exclusion, so assume the state taxes a gain that is excluded federally (FTB 540 booklet).
• Washington has no wage income tax in 2026, but it taxes long-term capital gains at 7% above a standard deduction ($278,000 for 2025; the 2026 amount was not yet published) and 9.9% on taxable gains above $1 million (WA DOR). A new 9.9% income tax on AGI over $1 million takes effect January 1, 2028 (WA DOR), which matters for a liquidity event that lands in 2028 or later.

For how a company sale treats vested and unvested equity, see if a company sells, what happens to my stock.

Common mistakes

• Tracking the headline valuation and never recalculating your percentage.
• Treating the preferred price as the value of your common shares.
• Forgetting that pool increases and SAFE conversions dilute you even in a round you were told was “small”.
• Planning a home purchase or private school tuition around a paper value that assumes a large exit.
• Letting startup equity become most of the family’s net worth with no written plan for when and how much to sell.

What to write down for your kids

Children see the outcome of a startup bet (a move, a windfall, or nothing) but not the reasoning. After each round, add a short entry to the family’s Decision Memo: your updated ownership, the preference stack, the exit size you need, and what you decided about exercising or selling. Conversations fade. Documentation compounds. Years from now, that record shows them how you weighed a concentrated, uncertain asset against the family’s needs.

Frequently asked questions

Is dilution always bad for employees?

No. In an up round, the new money is meant to grow the company faster than your percentage shrinks. In the example above, ownership fell from 1.00% to 0.52% while paper value rose from $400,000 to about $2.59 million. Dilution is a problem when rounds are flat or down, when the pool keeps growing at your expense, or when the preference stack outgrows realistic exit values.

Do employees get anti-dilution protection?

Almost never. Anti-dilution terms are written into preferred stock for investors. Common stock and employee options carry no such adjustment, which is why a down round shifts dilution toward employees and founders. Your main tools are asking for refresh grants, understanding the cap table, and deciding when to exercise or sell.

How much dilution should I expect per round?

It depends on how much the company raises relative to its valuation and how much it adds to the option pool. The new investor’s share is roughly the money raised divided by the post-money valuation, before any pool increase. Ask the company for the actual fully diluted count after each round rather than relying on rules of thumb.

Next step

Put your grant, the current fully diluted count and the total preferred raised into a simple waterfall like the one above, and run it at two or three exit values. If you would like help modeling it alongside your exercise plan and California or Washington tax, our tax management and investment risk management teams at Age Five Family Office™ can do it with you through a Tax & Wealth Assessment.

This is general education, and the right move depends on the family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

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