Introduction
Dilution occurs when a company issues new shares, which reduces each existing shareholder's percentage ownership of the company. While your ownership percentage decreases, dilution often benefits shareholders because the company's increased valuation can make your shares more valuable.
This article explains what dilution is, when it happens, and what it means for your equity.
What is dilution?
Dilution is the reduction in your ownership percentage that occurs when a company creates new shares. When new shares are issued, the total number of shares increases, which means your existing shares represent a smaller percentage of the company.
Important: Dilution affects your ownership percentage, but it doesn't change the number of shares you own. Your shares remain the same, but they represent a smaller piece of a potentially larger pie.
When does dilution happen?
Dilution can occur in several situations when a company issues new shares:
Equity financing rounds - When investors provide capital in exchange for ownership shares
Employee stock option exercises - When employees convert their stock options into shares
Convertible note conversions - When debt instruments convert into equity
Warrant exercises - When warrant holders convert their rights into shares
Stock-based compensation - When the company grants new shares to employees or advisors
Secondary offerings - When public companies issue additional shares to raise capital
How dilution works: An example
Let's look at a simple example to understand how dilution affects your ownership:
Before new shares are issued
Total shares: 900,000
Your shares: 1,000
Your ownership: 0.11%
Company value: €3M
Your equity value: €3,330
After new shares are issued
Total shares: 1,000,000 (100,000 new shares created)
Your shares: 1,000 (unchanged)
Your ownership: 0.10% (diluted)
New company value: €10M
Your equity value: €10,000
In this example, your ownership percentage decreased from 0.11% to 0.10%, but your equity value increased from €3,330 to €10,000 because the company's overall valuation grew significantly.
What does dilution mean for you?
Dilution has two key effects on your equity:
Your ownership percentage decreases
When new shares are created, you own a smaller percentage of the company. If you previously owned 0.11% and new shares are issued, you might now own 0.10% of the company.
Your share value may increase or decrease
The impact on your share value depends on why the shares were issued and how it affects the company's valuation:
Value increases - If the company raises capital at a higher valuation, your shares typically become more valuable despite the dilution
Value stays similar - If shares are issued at the current valuation (like option exercises), your share value remains roughly the same
Value decreases - If the company raises capital at a lower valuation than before (called a "down round"), your share value may decrease
Why companies issue new shares
Companies issue new shares for several important reasons:
Raising capital for growth - To fund operations, product development, or expansion
Attracting investors - To bring in expertise, networks, and financial resources
Compensating employees - To attract and retain talent through equity compensation
Strategic partnerships - To align interests with partners or acquirers
Converting debt to equity - To strengthen the balance sheet and reduce debt obligations
When a company issues shares strategically, the benefits often outweigh the dilution effect. The new capital, expertise, or resources can significantly increase the company's value, making all shareholders better off.
Learn more about dilution
For additional information about dilution and how it works in different scenarios, you can read this detailed explanation on Investopedia.