What Is Dilution?

Dilution occurs when a company issues new shares that result in a decrease in existing stockholders' ownership percentage of that company. Stock dilution can also occur when holders of 澳洲幸运5官方开奖结果体彩网:stock options, such as company employees, or holders of other optionable securities exercise their options. When the number of shares outstanding increases, each existing stockholder own🐼s a smaller, or diluted, percentage of the company, making each share less valuable.

A share of stock represents equity ownership in that company. When a firm's board of directors decides to take their company public, usually through an initial public offering (IPO), they authorize the number of shares that will be initially offered. This amount of outstanding stock is commonly referred to as the "float." If that company later issues additional stock (often called 澳洲幸运5官方开奖结果体彩网:secondary offerings) they have increased the float and thꦬerefore diluted their stock:▨ the shareholders who bought the original IPO now have a smaller ownership stake in the company than they did prior to the new shares being issued.

Understanding Dilution

Dilution is simply a case of cutting the equity "cake" into more pieces. There will be more pieces but each will be smaller. So, you will still get your piece of the cake only that it will be a smaller proportion of the total than you had been expecting, which is often not desired.

While it primarily affects equity ownership positions, dilution also reduces the company's earnings per share (EPS, or net income divided by the float), which often depresses stock prices in the market. For this reason, many public companies publish estimates of both non-diluted and diluted EPS, which is essentially a "what-if-scenario" for investors in the case new shares are issued. Diluted EPS assumes that potentially dilutive securities have alread🎃y been converted to outstanding shares.

Share dilution may happen any time a company raises additional equity capital, as newly created shares are issued to new investors. The potential upside of raising capital in this way is that the funds the company receives from selling additional shares can improve the company's profitability and growth prospects, and by extension the value of its stock.

Understandably, share dilution is not often viewed favorably by existing shareholders, and companies sometimes initiate 澳洲幸运5官方开奖结果体彩网:share repurchase programs to help curb the effects of dilution. Note that 澳洲幸运5官方开奖结果体彩网:stock splits do not create dilution. In situations where a company splits its stock, current investors receive additional shares while theꦺ price of the shares is adjusted accordingly, keeping their percentage ownership in the company static.

General Example of Dilution

Suppose a company has issued 100 shares to 100 individual shareholders. Each 澳洲幸运5官方开奖结果体彩网:shareholder owns 1% of the company.💦 If the company then has a secondary offering and issues 100 new shares to 100 more shareholders, each shareholder only owns 0.5% of the company. The smaller ownership percentage also diminishes each investor's voting powe🍷r.

Real-World Example of Dilution

Often times a public company disseminates its intention to issue new shares, thereby diluting its current pool of equity long before it actually does. This allows investors, both new and old, to plan acc🐷ordingly. For example, MGT Capital filed a proxy statement on July 8, 2016, that outlined a stock option plan for the newly appointed CEO, John McAfee. Additionally, the statement disseminated the structure of recent company acquisitions, purchase🔴d with a combination of cash and stock.

Both the executive stock option plan as well as the acquisitions are expected to dilute the current pool of outstanding shares. Further, the proxy statement had a proposal for the issuance of newly authorized shares, which suggests the company expects more dilution in the near-ꦗterm.

Dilution Protection

Shareholders typically resist dilution as it devalues their existing equity. 澳洲幸运5官方开奖结果体彩网:Dilution protection refers to contractual provisions that limit or outright prevent an investor's stake in a company from being reduced in later 澳洲幸运5官方开奖结果体彩网:funding rounds. The dilution protection feature kicks in if the actions of the company will decrease the🍌 investor's percentage claim on assets of the company.

For example, if an investor's stake is 20%, and the company is going to hold an additional funding round, the company must offer discounted shares to the investor to at least partially make up for the dilution of the overall ownership stake. Dilution protection provisions are generally found in 澳洲幸运5官方开奖结果体彩网:venture capital funding agreements. Diluti♚on protection is sometime♒s referred to as "anti-dilution protection."

Similarly, an anti-dilution provision is a provision in an option or 澳洲幸运5官方开奖结果体彩网:convertible security, and it is also known as an "anti-dilution clause." It protects an investor from equity dilution resulting from later issues of stock at a lower price than the investor originally paid. These are common with 澳洲幸运5官方开奖结果体彩网:convertible preferred stock, which is a favored form of venture capital iꦬnvestment.