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Stock dilution

Imagine a friend is coming over so you decide to order a large pizza and split it in half. However, another friend crashes the party and now 3 of you are sharing the pizza. Each person still gets pizza except the amount they get per person decreases.


You can think of shares in the same way. A stock dilution occurs when a company issues or creates new shares, causing the original shareholders percentage of ownership in the company to reduce. For any given value of a company, if you add one more share then there’s one more person “eating the pizza”. This negative impact on the value of a slice or share of a company is called dilution.


The primary reason why a company would choose to dilute its shares would be to raise additional capital. Even though this move affects the current shareholders, it provides the company with the potential for higher profit, growth and eventually increasing the value of its stock.


Unlike stock splits where the price of the share is adjusted to reflect the same percentage ownership, a stock dilution does affect the percentage of ownership a shareholder has in a company.


For example: if company LMNO issues 100 shares to 100 shareholders, each shareholder has a 1% claim to the company. However, if LMNO were to issue 100 new shares to 100 different shareholders, this would result in stock dilution, causing each shareholder to only have 0.5% claim to the company. This would also have a negative effect on voting rights since each shareholder now has a smaller claim to the company, its assets and decisions.