What is dilution?
Dilution is a reduction of the total percentage (%) of a company owned by an entity when new shares are issued.
For example, let’s say you own 1,000 shares of a Company ABC. When 100 new shares of ABC is issued to a new investor or shareholder, what happens to your ownership percentage?
- Total number of shares (before): 1,000 shares
- Total number of shares (after) : 1,100 shares
- So, you own 1,000 shares out of 1,100 shares: (1,000/1,100) x 100=91%
With the issuance of the 100 new shares, your ownership of the company dropped from 100% to 91%. This is called a 9% dilution.
Note: Although your ownership percentage in company ABC has dropped, the absolute value of the stock in dollars and cents would have increased (typically, unless it’s a down round).
Dilution typically happens in 3 scenarios:
1. When you are raising capital: As shown above, if you have a new investor who injected cash into your company, you will be diluted.
2. If you issue stock options or warrants: A stock option or warrant owner can decide when they would like to enter your capital structure. Hence, when they do, you will face a dilution.
3. When you have raised using convertible debt: Convertible debt means that they loan that you took can be converted to equity when a trigger event happens. The trigger event is normally negotiated when you get the loan. So, when the event happens, you will be facing a dilution.