A recurring question in virtual shareholdings: Do virtual shares dilute in a financing round?

The answer is yes and no, because virtual shares are dilutive in percentage terms, but not in economic terms (which is what matters).

To explain, let’s take an example: A limited liability company has a share capital of EUR 25,000 with 25,000 shares at EUR 1 each and an additional 2,500 virtual shares issued (with an arithmetical nominal amount of EUR 1 each). This means in total there are 27,500 (real and virtual) shares. Employee A is allocated 500 of the 2,500 virtual shares. Thus, he has a participation of 500/27,500 or ~1.82%.

If the share capital is now increased by EUR 6,000 as part of a financing round, there will then be a total of 33,500 (real and virtual) shares. As a result, our employee would only have a shareholding of 500/33,500, i.e., ~1.49 %. In percentage terms, the employee’s shareholding therefore has been diluted.

But: The economic value of each real and virtual share has not changed due to the capital increase, because the entire company has become worth more: Let’s assume that the company was worth EUR 5,500,000 before the capital increase (i.e., pre-money). In this case, the value of one share, taking into account the virtual shares (in VC-speak: fully diluted), would be EUR 200. The investor who takes over the new shares with a nominal value of EUR 6,000 therefore must pay EUR 1,200,000 to the company.

After the capital increase (i.e., post-money), the company then is worth EUR 5,500,000 + EUR 1,200,000 = EUR 6,700,000. Thus, the value of each of the 33,500 real and virtual shares remains at EUR 200.

It is therefore important to understand that a virtual shareholding does not give a person a certain percentage in the company, but a certain number of virtual shares. Incidentally, this is no different from a real shareholding: A shareholder also holds a certain number of shares and not a fixed percentage in the company. If he wishes to avoid dilution in percentage terms due to a capital increase, he has the right to acquire new shares against payment of the issue price – in our example EUR 200. If he does not pay, his shareholding is diluted in the same way as with virtual shares.