Share dilution

Stock dilution, also known as equity dilution, is the decrease in existing shareholders’ ownership of a company as a result of the company issuing new equity. New equity increases the total shares outstanding which has a dilutive effect on the ownership percentage of existing shareholders. This increase in the number of shares outstanding can result from a primary market offering (including an initial public offering), employees exercising , or by issuance or conversion of convertible bonds, preferred shares or warrants into stock. This dilution can shift fundamental positions of the stock such as ownership percentage, voting control, earnings per share, and the value of individual shares. A broader definition specifies dilution as any event that reduces an investor's stock price below the initial purchase price.

Control dilution describes the reduction in ownership percentage or loss of a controlling share of an investment's stock. Many venture capital contracts contain an anti-dilution provision in favor of the original investors, to protect their equity investments. One way to raise new equity without diluting voting control is to give warrants to all the existing shareholders equally. They can choose to put more money in the company, or else lose ownership percentage. When employee options threaten to dilute the ownership of a control group, the company can use cash to buy back the shares issued.

The measurement of this percent dilution is made at a point in time. It will change as market values change and cannot be interpreted as a "measure of the impact of" dilutions.

Earnings dilution describes the reduction in amount earned per share in an investment due to an increase in the total number of shares. The calculation of earnings dilutions derives from this same process as control dilution. The net increase in shares (steps 1-5) is determined at the beginning of the reporting period, and added to the beginning number of shares outstanding. The net income for the period is divided by this increased number of shares. Notice that the conversion rates are determined by market values at the beginning, not the period end. The returns to be realized on the reinvestment of the proceeds are not part of this calculation.

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