Dilution: the quiet tax on equity incentives

You were promised 5%. Now you’ve got 4% and no one told you why. Welcome to the quiet tax on equity incentives: dilution.

Dilution: hope or hazard?

In theory, dilution is the price of growth. When a company raises new capital or brings in key hires, the pie should get bigger, so even a smaller slice could be worth more. This is the hope that underpins every equity incentive: that the company’s success will more than offset any reduction in percentage ownership.

But this only works if the value created outpaces the dilution and if employees understand and trust the process. When communication is poor or growth stalls, dilution feels less like a necessary trade-off and more like a quiet tax on hope.

The FNZ case: when ownership becomes an illusion

As the recent Sunday Times’ reporting on FNZ shows, that equity promise can be fragile. Once presented as a shared success story, the fintech giant is now facing litigation in New Zealand. Staff allege that three fundraisings in 2023-24, conducted on preferential terms for institutional investors, left their percentage holdings worth far less than expected when compared to the company's headline $20 billion valuation.

The issue is not just the maths of dilution, though percentage ownership inevitably shrinks when new shares are issued. It is the combination of percentage erosion and preferential deal terms that can make employees feel their stake has been quietly devalued, despite headline valuations suggesting otherwise.

What “anti-dilution” really means

There’s a lot of loose talk about “anti-dilution protection.” In reality, very few employee share plans contain formal anti-dilution rights. These are more commonly seen in investor protections, like pre-emption rights or weighted-average price adjustments.

For employees, anti-dilution protection - if it exists - usually takes one of three forms:

1. Top-up awards: Existing holders are granted additional options to maintain their relative percentage (rare and discretionary).
2. Formula-based grants: Some awards are expressed as a fraction of the company’s share capital from time to time (e.g. “1% of fully diluted share capital”) .
3. Pool caps and remco vetoes: A ceiling on the total pool (e.g. 10% fully diluted) and a requirement for committee consent before new awards can be made, creating a structural check on internal dilution risk.

The “fixed percentage” approach sounds neat, but in practice it still reallocates dilution risk between stakeholders. It avoids surprises for management, but someone else on the cap table inevitably bears the adjustment.

Strategies

If you’re advising management or structuring a plan, the goal isn’t to eliminate dilution (you can’t), but to make it measured and managed. Here’s how:

• Set a firm pool size upfront: Clearly allocate what’s spoken for, what’s reserved and what’s available for future hires.
• Document grant policies: Explain how future allocations will be approached, this builds trust even if discretion is retained.
• Ensure transparency when grants are made: The “why” matters. Issuing 2% to a Chair who unlocks an exit may be dilutive, but it’s value-accretive.
• Model dilution over time: Help management and employees understand what “5%” might really mean post-hire, post-fundraise, post-acquisition.
• Offer secondary liquidity opportunities: Allow employees to sell a portion of their vested equity through structured buy-backs or secondary sales, so they can realise value before a full exit and reduce the risk of dilution eroding their reward

The wider point

Dilution, at its best, is a sign of ambition - a company raising capital, hiring talent and growing the pie for everyone. The hope is that, even as your slice shrinks, the overall pie becomes so much larger that you’re still better off. 

But a promise of equity quickly loses meaning if it shrinks without explanation. For employees, what felt like “5%” at the start can look more like “4%” by the time of exit, unless the journey is transparent. Good incentive design is not just about mechanics or percentages; it is about building a culture of fairness, clarity and shared success.

At Burges Salmon, we help clients design equity incentives that genuinely align interests and build trust. We believe the best schemes are not just technically robust, but also transparent, fair and clearly communicated, so that growth is shared, risks are understood and the promise of ownership is real.