When 1% Isn't Really 1%: The Hidden Equity Dilution Trap

The Common Scenario

A company is formed. The founders issue themselves 1,000,000 shares in total. Clean, simple, and easy to track.

Soon, they decide to bring on an advisor. They want to incentivize this person with 1% equity, and they're smart enough to do it the right way: in the form of stock options with a vesting schedule.

So, they grant the advisor 10,000 options, thinking:

1% of 1,000,000 shares = 10,000 shares

The Hidden Problem

The problem? As soon as those options exist, the company no longer has 1,000,000 shares on a fully diluted basis—it has 1,010,000. Which means the advisor's 10,000 options are actually 0.99%, not 1%.

The Dilution Cascade

1️⃣

First Advisor

10,000 options out of 1,010,000 total = 0.99%

2️⃣

Second Advisor

10,000 options out of 1,020,000 total = 0.98%
First advisor also diluted to 0.98%

3️⃣

Each Additional Grant

Everyone gets diluted further...

Fast forward a few months. The company brings in a second advisor and again offers "1%." Another 10,000 options are granted. Now the fully diluted share count is 1,020,000. The new advisor has 0.98%, the first advisor is diluted to 0.98%.

This cycle repeats itself each time another "1% grant" is made. Everyone thinks they're getting what was promised—but the math doesn't support it.

The Legal Nightmare

Even worse, what happens if our founders are granting it through a poorly written document that says the grantee is being granted "1%"?

The worst-case scenario:

An advisor comes back in three years (after multiple dilutions) and waves around his grant agreement saying "this says I have 1% and doesn't say anything else"

Replying with "Oops, that's not what we meant" isn't going to be a valid defense.

Why It Happens

The mistake stems from granting equity on an issued-shares basis rather than on a fully diluted basis. By failing to plan for future equity awards, founders end up making promises that don't quite hold true.

❌

Wrong Approach

Granting based on currently issued shares

✅

Right Approach

Granting based on fully diluted share count

The Better Way: Establish an Option Pool

Sophisticated startups handle this by creating an option pool up front.

The Right Way: Option Pool Example

In our example, with 1,000,000 founder shares, the company might authorize a 10% pool (111,111 shares), which brings the fully diluted total to 1,111,111 shares.

Now when granting 1%:

Grant 11,111 options (exactly 1% of fully diluted)
Advisor truly has 1% at time of grant
Founders know what dilution they've accounted for
Cap table stays clean and predictable
Still have 9% earmarked for future use

This approach keeps everyone aligned. The advisor knows they truly have 1% at the time of grant, and the founders know what dilution they've already accounted for.

Important documentation note:

The grant document will not say 1%, it will say 11,111 shares and will then be diluted along with the founders' shares in future events.

The Takeaway

Equity is one of the most powerful tools founders have for building a team, but it's also one of the easiest to mismanage. Without an option pool, every "1%" becomes something less than 1%, and those discrepancies add up quickly.

The Fix is Simple

Create a meaningful option pool early (commonly 10–15%)
Measure grants as a percentage of the fully diluted cap table
Tie advisor and employee equity to vesting so incentives are long-term and aligned

That way, when you grant 1%, it's actually 1%.

Final Thoughts

Getting equity grants right from the beginning isn't just about math—it's about building trust with your team and avoiding legal complications down the road.

The difference between granting equity on an issued-shares basis versus a fully-diluted basis might seem small at first, but it compounds over time and can create significant problems during fundraising or exit events.

If you'd like to discuss your cap table needs with Bob, connect with him below – because every point matters.