Dilution is what happens when additional shares are issued by a company, so that they can raise more capital.
When a company issues new shares, it means the earlier investors now own a smaller percentage of the company. However, if the company is doing well, the company will have a higher valuation in the next funding round and possibly a different price per share. This means that while investors (and the founders) now own a smaller slice of the total pie, the pie is bigger than what it was before and so their shares are worth more than they were previously too. Everybody wins.
As a hypothetical example, let's say that the founders control 80% of a company after their seed funding round. This company is valued at $5M, so their shares are worth $4M, 80% of the total. After many funding rounds, the founders' shares are diluted to just 10% of the company, but the company is now valued at $400M. This means that the founders' shares are worth $40M, a 10x increase in value.
However, dilution can be negative too: if the company isn’t growing, a future funding round can become what is known as a down round. A down round is when a company raises more capital but at a lower valuation, which can increase the rate of dilution as well as reduce the value of investors’ holdings by resetting the price per share.