When it comes to equity crowdfunding, one of the issues that generates doubt among companies is the dilution of corporate shares. It is a physiological phenomenon whenever a capital increase is made, but it is often perceived as a governance risk or as a sign of loss of control, especially in the case of equity crowdfunding where many shareholders can enter a company. In reality, dilution can be managed easily and transparently, and can even be a strategic lever to support the growth of the company.

In this article we see What is really share dilution in equity crowdfunding, how to manage it and what steps to take to turn it into a useful tool in the capital-raising journey.

What is dilution of corporate shares

Dilution is a natural effect of the’Entry of new investors into a company. Each time share capital is increased to raise money to be injected into the company, new shares are issued: as a result, the shareholding percentage of existing shareholders decreases, although the absolute economic value of their shareholding may remain stable or grow.

How dilution works in a capital increase

During a capital increase, the company puts up new units or shares for sale. These shares are added to existing shares, increasing the total number outstanding.
The result is simple:

• current members continue to own the same number of shares as before;
  
• their percentage share decreases because their overall shares increase;
  
• the company gets new capital to use to develop products, marketing, structure or new projects.

Dilution is not an anomaly: it is the normal condition in any equity-financed growth operation.

“Good” dilution vs. “bad” dilution”

Not all dilution is equal. It is useful to distinguish two cases:

• “Good” dilution”: when the entry of new members brings useful resources for growth. In this situation, even if the percentage of existing members falls, the value of the firm increases and more than compensates for the percentage effect;
  
• “Bad” dilution”: when the pre-money valuation is too low or you make several close rounds without a long-term strategy. In this case you actually lose too much capital without a corresponding increase in value.
  

The focus is on strategic coherence: dilution is good if it is embedded in a clear path, supported by a vision for growth and a credible financial plan.

Dilution: what changes in member's rights

Dilution affects the percentage capital structure, but does not automatically change the members' rights, especially in equity crowdfunding campaigns. Indeed, the share structure for equity crowdfunding partners can be configured with limited or differentiated administrative rights, precisely to protect corporate governance and strategy.

Crowd investors typically get shares with economic, not management rights: voting rights remain in the hands of founding members only and eventually is extended to a few, selected, strategic partners.

Why some entrepreneurs see dilution as a problem

Although dilution is a normal phenomenon in any capital increase, many companies perceive it as a risk. Often this concern stems from a partial knowledge of the functioning of equity crowdfunding. In this section we analyze the most recurrent reasons for fear and see why, in practice, they are often unfounded.

One of the most common concerns is the possibility that the entry of many small members will result in a loss of control by the founders.

This fear stems from imagining crowd investors as equals to founding partners, able to affect business decisions. In reality, most equity crowdfunding campaigns, as we have already mentioned, involve Shares with no voting rights or very limited administrative rights, precisely to preserve the governance of the enterprise.

Another perplexity concerns the complexity of governance When the membership base becomes large.
This fear is understandable, but in the operational reality of crowdfunding the problem almost never occurs, for two reasons:

1. Quota structures designed for the crowd: the company should configure functional share categories, such as non-voting or limited-voting shares on non-strategic matters.
   
2. Centralized representation: investors are often grouped through a representative or corporate vehicle, thus a single entity that acts as a proxy for all crowd members, simplifying all assembly activities.

In this way, even hundreds of small members do not generate additional complexity in corporate management.

Another misinterpretation is. Associating dilution with impairment.

In fact, divesting a smaller percentage of capital may be equivalent to obtaining a higher economic value if the pre-money valuation is sound and consistent with the market.

The real issue is not dilution per se, but the relationship between capital raised, shares sold and value generated through that capital.

When the collection funds marketing, product development or business expansion activities-activities that in many cases significantly increase the value of the enterprise-the dilution perceived as a “cost” actually becomes an investment in future growth.

Why dilution in equity crowdfunding is different 

The dilution generated by an equity crowdfunding campaign is not comparable to that of a round with an investment fund or with one or more business angel. The nature of the crowd, its objectives, and the way the shares are structured make the impact on the governance and management of the enterprise very different. Here we analyze the three elements that characterize this difference.

1. The crowd does not enter to take control

Investors participating in an equity crowdfunding campaign are not trying to become entrepreneurs and influence the strategic choices of the company.
Their main motivation is not to become active members of governance, but to support a project they believe in, access dedicated member benefits, and take part in the growth of the enterprise.

Especially since investors are for the most part customers or potential customers who see investment as a way to support the company and share in future profits, but have no business management experience.

2. Lots of small partners = no dominant partners

A fundamental difference between equity crowdfunding and institutional investors is the distribution of capital. In a round with a VC fund or with structured business angels, the divested stake is often concentrated on a very small number of parties, each of whom may become significant enough to affect business decisions.

In crowdfunding, the opposite happens:

• dues are divided among hundreds or thousands of small members;
  
• None of these hold a significant percentage;
  
• No one has the strength to condition the direction of the enterprise.
  

This mechanism allows the company to obtain capital without surrendering autonomy or strategic vision.

3. Differentiated dues by statute

Unlike a normal capital increase, equity crowdfunding allows for the differentiation of shares and related rights within the corporate charter in the ways we have already explained. In addition, it is possible to open capital stock without including new members directly in captable, through an alternative regime of share header.

How to manage dilution strategically

Dilution is not an event to be endured: it can be planned, controlled, and used as leverage to support business growth. Conscious management starts with three key elements: pre-money valuation, supply structure, and planning for future rounds.

Set up the pre-money valuation correctly

La pre-money valuation is the starting point for figuring out how many shares you really need to give up to raise the desired capital.
Market-consistent valuation makes it possible to:

• Contain dilution,
  
• Clearly communicate to investors that the project is sound,
  
• Ensure balance between capital raised and share sold.
  

A rating that is too low unnecessarily increases dilution; one that is too high risks making the offer lack credibility. The goal is to position yourself realistically, supporting each issue with metrics and perspectives.

Structuring the offer intelligently

The second lever for governing dilution is supply-side design. A equity crowdfunding campaign allows for the use of legal and technical tools that keep governance stable while enabling new investors to be welcomed.

Some typical expedients:

• Non-voting shares or limited voting: prevent small members from affecting management.
  
• Differentiated quota categories: to distinguish rights of the founders and rights of the crowd.
  
• Clear property rights: to protect investors and company without creating future asymmetries.
• Drag and co-sale clauses: to define the right and manner of sale of shares by all members.
  

These solutions are now well established in market practices and are regularly adopted in campaigns to simplify the post-campaign membership management.

Consider future rounds

Careful management of dilution affects not only the current campaign but also the company's future path.
It is convenient to define from the beginning a Realistic roadmap of upcoming capital increases, providing:

• How much capital will be needed in the next 12-36 months,
  
• How much share you are willing to give up in total,
  
• How to distribute divestments among crowdfunding, professional investors, or hybrid instruments (such as the PFI),
  
• How to maintain leeway to avoid excessive or unplanned dilution.

Upstream planning avoids arriving at the second or third round with little available capital to give away or with too much dilution already accumulated. Instead, it allows for the construction of a harmonious and modular path, in which crowdfunding becomes part of an overall strategy and not an isolated event.

How to present the issue of dilution to investors

Managing the issue of dilution well also means communicating it clearly to investors during the campaign. Crowd investors are not financial professionals: they need simple, transparent, and consistent information that enables them to understand what is involved in joining the company and why dilution is not a real risk to their investment.

The communication must:

• Describe in a simple way what happens when new quotas are issued;
  
• indicate in which cases dilution occurs and what is the expected benefit (growth, investment, marketing, product development);
  
• Clarify which rights are due to investors and which are reserved for founding members.

Transparent communication avoids misunderstandings and helps build trust, one of the most crucial factors in conversion to investment.

La dilution of shares, moreover, should be placed in the broader context of participating in a crowdfunding campaign. For crowd investors, unlike traditional investors, they tend to percentage of participation is not the only element of interest.
Investment is evaluated from a broader perspective, including:

• Community membership and identity value,
  
• exclusive member benefits,
  
• Early or privileged access to products and services,
  
• potential future economic gain.
  

This is why in equity offerings are so important the reward: participation in the company becomes part of a larger value package, perceived as an experience and not just a financial transaction.

Finally, another essential element is to help investors understand How corporate life really works.
To do this, it is useful to include in the campaign information such as:

• The distinction between economic rights and administrative rights;
  
• The role of the investor representative (if any);
  
• The fact that governance remains unchanged even with many members;
  
• How post-campaign communications take place;
  
• When and how dilution might occur in the future (e.g., in the case of new rounds).

In this way, investors perceive dilution for what it is: a normal consequence of business development, managed through special tools and procedures with a view to creating increasing value for all shareholders.