The reduction in an existing shareholder's ownership percentage that occurs when new shares are issued.
Dilution happens whenever a company issues new shares. If a company has 10 million shares outstanding and issues 2 million new shares to investors, each existing shareholder now owns a smaller percentage of the company — even though they hold the same number of shares. A founder who owned 50% (5M of 10M shares) now owns 41.7% (5M of 12M shares).
Dilution is a normal and expected part of building a venture-backed company. Each fundraising round dilutes existing shareholders. Issuing options to employees also dilutes existing holders. The tradeoff is that the new capital or talent the company receives should increase the company's overall value — so even though your percentage is smaller, the value of your stake might be larger.
What matters isn't just your percentage, but the value behind it. Being diluted from 50% to 35% in a company that just raised $5M and increased its valuation from $2M to $15M is a good outcome. Dilution becomes a concern when shares are issued at too low a valuation, when too much is given away too early, or when option pool shuffles inflate dilution before a round closes.