Investing in a startup means buying a slice of ownership, called equity. But that slice can shrink, and it can sit behind other people who get paid first. Here's what those words mean, without the jargon.
What you'll have by the end: a plain-English grip on shares, dilution, and preferences, and a worked example you can follow.
The words, in plain English
- Shares: the units of ownership. Your slice = your shares ÷ all the shares that exist.
- Dilution: when the company issues new shares (to raise money or pay staff), the total grows, so your same shares become a smaller slice. This is normal, and it's why "1%" today may be less later.
- Option pool: shares set aside to hire people. It dilutes everyone, including you.
- Liquidation preference: the deal that some investors get their money back first if the company sells. It can mean a sale looks good on paper but pays common shareholders little.
A worked example
Say a company has 1,000,000 shares and you buy 10,000. You own 1%. Later it raises money and issues 250,000 new shares. Now 1,250,000 exist, and your 10,000 is 0.8%, you didn't lose shares, the pie got bigger. If the company sells for $10M and earlier investors have a preference that pays them $4M first, only the remaining $6M is split by ownership, so your slice is a percentage of $6M, not $10M.
Your percentage is a moving number, and it may sit behind other people's money. Before you invest, ask two things: how much will I be diluted, and who gets paid first?
Why it matters
None of this means startups are a bad bet, it means the headline "I own X%" is only the start. Understanding dilution and preferences is the difference between knowing what you own and guessing. To size up the company itself, use the research a business framework.