ArticleHow much should I dilute?
The invariable question being asked by a Startup which has burnt all his cash like the Joker in the Dark Knight, at the time of fund raise.
And the same question which have to be answered every other day by every other financial finance professional. A true Groundhog Day!
Dilution stakes are always high.
The Mathematical answer to this is to draw up the valuation. Start with finding the value of the Enterprise. First use the equivalent term to Rocket Science in Finance, named Discounted Cash Flow. Project at the Cash Flows. Find out Cost of Equity, Discount and Arrive at the Enterprise Value. Much easier to type and when you have to explain it to an Entrepreneur, it turns into a Nolan Script of Memento. You don’t know where it starts nor where it ends
There also exists extras such as Multiples, Net Book Value, Berkus and so on to arrive at the enterprise Value.
Figure out the Fund requirements for this round, divide the Fund needed with the Valuation, alas, the Dilution %.
Straight Forward, Plain and Emotionless way on arriving how much the Founder has to part way in the Enterprise.
The Dilution which could range from 1% to 100%, has very deeper significance. The % the founders keep with them and the % they have to off load has not only financial impact but a very huge non-financial impact.
So, going back to the First Question, Mathematical Way which is theoretically correct needs to be analyzed further with the lens of a Corporate Lawyer.
A 2% difference between 49% and 51% will decide on the party which can exhibit the control over the other. Having 50% and 50% saying they are made for each other will result in stalemate in decision making. So figuring out the right shareholding % can strengthen the bond and can extend the relationship and make the entity stay true to the Going Concern Concept.
The 2 Key Shareholding to be kept in mind were the following:
1) 51% and 49%
2) 74% and 26%
3) 76% and 24%
Significance of 51% and 49%: - Ceding the Operational Control
Having 51% and 49% shareholding is quite popular in a JV structure. From the Financial Standpoint, 2% differential in the shareholding will not have a major impact in the profits (losses goes without saying) to be split among them. But from a corporate governance point, it will have a huge say as this will results in the operational control in the hands of one party. Though the difference is a negligible 2%, the one who is holding 51% has actually have the control on the key day to day transactions of the company. Any transactions which can be passed as ordinary resolution can be made by that majority shareholder without the validation of the minority. In simple words, when 49% goes to arm wrestle 51%, on all the times where simple touch down is enough 51 will come in top though the weight difference is only 2%.
(i) Reliance and Network 18:
Here’s the short and crisp story. Network 18 was Fastly losing money. Needed a person with deeper pockets to help them out. Help and funds came from Reliance through something called as Zero Coupon Optionally Convertible Debentures. As the instrument is Zero Coupon, Network 18 need not worry about the interest. Kind of like free money at that point when injected into the Network 18. The time horizon to convert into equity was 10 years. Network 18 recovered, recouped their losses. Then came the curtains to the Raghav Bahl after 2.5 Years. Reliance wants to convert. They have converted the Zero Coupon Optionally Convertible Debentures and resulting in a stake of 73% handing over the operational control of the company.
Significance of 74% and 26%: - Blocking the Special Resolutions
The side which has 74% are definitely the one which has the operational control over the day to day affairs of the company. But sometimes that may not be enough. There musts exists a situation where certain extraordinary decision needs to be taken which can warrant or influence the operation of the company. Such decisions needs to be taken only with the voting of 76% of the members. In other words a simple majority will not have any material use on that decision making. The party with 26% can block such decisions by firmly saying no and can go against the wish of the majority. Such existence of special resolution on key matters are protecting the interests of the minority. So having a 2% over 49%, promises the operational control and having a 2% less on 76%, can result on losing out on transactions requiring special resolution.
(i) Reliance and Dunzo
Dunzo, a quick ecommerce startup has raised funds from Reliance and has given away 26% of the Company and rests being retained among the Dunzo and the other investors. Days passed, cash burnt. Dunzo wanted to do another round of fund raise. Knocked on the doors of existing shareholders, didn’t get any positive answers. Left with no option, Dunzo wants to look outside for the fund raise. There comes the blockage by Reliance, a 26% Minority shareholder who has firmly said NO. Any external fund raise needs an approval of 76%, in the given case as Reliance holds 26% it was firmly able to block the request and held the company hostage.
Significance of 76% and 24%: - Supermajority for unrestricted decision making
The party which can hold upon 76% and above can have unrestricted and uninterrupted access on the decision making of the company. Both the ordinary resolution and special resolution can be passed without the need of any other person and can exhibit his absolute domination on the affairs of the company. In some way, the person who holds 24% is more of a silent investor in the company without any real say in the way things can be operated.
(i) Tata Sons vs Cyrus Mistry
The Tata sons was controlled by 2 groups namely Tata Trusts, holding more than 76% (direct and indirect) and the other by Shapoorji Pallonji Group which held 18.4%. The Cyrus Mistry representing the Shapoorji Pallonji Group was appointed as the Chairman of Tata Sons. However due to the fall out in relationship he was ousted by Tata Sons from the position as it held more than 76%. Cyrus Mistry has taken this matter to supreme court with no vein as the Tata Sons has held supermajority.
Conclusion
From dilution wise, every single basis points higher or lowers will go a long way in the decision making, As far as keeping the key % in mind at the dilution those are the above as they have significant impact on the Corporate Governance and on facilitating the Decision Making in the enterprise.
Ashwin V
Jul 2, 2025 · 5 min read
