What is Dilution – Meaning in the Stock Market and Shareholding

Key Highlights
 

1. Dilution of a company happens for various reasons. For example, startups actively dilute their shares for funds at the initial stages, and established companies dilute to balance the power. 
    
2. Major causes of dilution include IPOs, secondary offerings, ESOPs/RSUs, convertible instruments, and startup funding rounds.
    
3. Diluted EPS disclosure, pre-emptive (rights) issues, and anti-dilution protect people during dilution of the company. 

Dilution happens when a company issues new shares. This reduces the percentage of ownership held by existing shareholders. It lowers their control and can also decrease the value of their holdings.

For example, Riya holds 1,000 shares of a company. She owns 10% of it. One day, the company issues 5,000 new shares to raise money. Suddenly, Riya’s shareholding drops to just 6.6%. 

This table summarises both situations.
 

Though Riya didn’t sell even a single share, her ownership decreased by 3.4%. This is what we call dilution. Let’s know more about it and how it impacts the stock market and shareholding in this blog. 

Read More – What Is FPO In The Share Market: Full Form, Features & How It Works

How Does Dilution Occur? 

Dilution happens when a company increases the number of shares. The ownership percentage decreases for the existing shareholder. Let’s see the main ways this occurs with examples.

1. Initial Public Offering (IPO)

When a private company sells shares to the public for the first time, it creates new shares. Since the total number of shares increases, the original owners now hold a smaller percentage.

For example, when Zynga went public, it issued 100 million Class A shares at $10 each. After that IPO, the total shares jumped from just internal stock to over 760 million total shares when including other classes and options. This meant that early holders owned much less of the company. 

2. Secondary Stock Offerings

Sometimes, even after going public, a company issues extra shares to raise more money. This increases the total share count, reducing the ownership percentage of existing shareholders.

For example, Tesla raised $2.03 billion through a secondary offering in February 2020. That added more shares on top of existing ones. This resulted in about a 4.6% dilution for existing shareholders. 

3. Employee Stock Options (ESOPs) and RSUs

Companies often reward employees with stock options or restricted stock units. When these are converted into actual shares, the overall pool of shares grows, diluting others’ ownership.

For example, in Q4 2024, Yandex awarded employees 8.9 million RSUs. Each awarded RSU becomes a new share when vested. So the more RSUs granted, the more your part of the company shrinks.

4. Conversion of Bonds, Warrants, or Preferred Shares

Certain financial investments, like bonds or warrants, can be converted into shares. When that happens, the number of shares rises, and existing shareholders’ percentage goes down.

For example, Apellis Pharmaceuticals issued convertible debt equating to roughly 6 million new shares. With about 60 million shares outstanding, this meant a dilution of around 10% for existing shareholders.

5. Startup Funding Rounds

Startups raise money by giving new shares to investors in different funding rounds. Each time this happens, the earlier owners’ slice of the pie gets a bit smaller.

For example, based on Carta’s 2023 data from 1,229 funding rounds:

• Seed round: Founders give up about 20% of the company.
   
• Series A: Another 20% goes to new investors.
   
• Series B: About 15% more.
   
• Series C: Between 10–15%.
   
• Series D: Around 10%.

It means that if a founder owned 100% at the start, by Series D, they usually end up with less than 30–35% of the company. This is because each round reduces their share.

This table summarises how dilution happens and how it affects shareholders
 

So, as you have seen, there are multiple ways of diluting the company. If you want the public to own more shares, you issue an IPO; if you want to reduce shareholders’ power, you issue a secondary offering and likewise. 

What are the Types of Share Dilution?

There are 3 types of dilution. The table given below explains all 3 and also mentions the impact on shareholders in all 3 cases. 
 

To understand it more clearly, let’s take an example.

Example: a startup valued at ₹10 crore has 1,00,000 shares at ₹1,000 each, fully owned by the founder. To raise funds, the company issues 25,000 new shares to an investor at a lower price of ₹600 per share.

Also Read - The Bootstrap Loan Strategy: How Do Startups Grow Without Equity Dilution?

The table shows how different aspect of these new shares triggers different types of dilution.
 

In one fundraising round, the founder’s ownership was reduced to 80%, the per-share value dropped to ₹920, and control was reduced. 

How are Investors Affected?

When a company issues more shares, it doesn’t just change ownership; it directly affects investors’ returns and influence. The impact is usually seen in earnings, price movements, control, and even dividends. This section talks from the investors’ POV and how they are affected by dilution.

1. Earnings Per Share (EPS)

EPS drops because the company’s profit now has to be divided among a larger number of shares. For example, if profit is ₹10 lakh and shares double, each share gets half the earnings it did before.

2. Share Price

Dilution often puts pressure on the stock price. Investors worry about lower earnings per share, which can cause the market price to fall in the short term.

3. Voting and Control Loss

More shares mean existing investors hold a smaller percentage of the company. This reduces their voting power and influence on major company decisions.

Managing and Mitigating Dilution

Dilution is not good for existing investors. However, there are some ways to reduce the impact of dilution. Let’s discuss them in the content below.

1. Diluted EPS Reporting

Companies don’t just show basic Earnings Per Share (EPS). They also report diluted EPS, which includes all possible future shares from stock options or bonds. This gives investors a clearer and safer picture of how much profit belongs to each share.

For Example, a company with ₹900,000 net profit and 300,000 basic shares would have ₹3 EPS. If there are 50,000 more potential shares from conversions, the diluted EPS drops to ₹2.57. Investors can see that profit per share could be less if all those extra shares materialise. 

2. Anti-Dilution Provisions

These are rules in investor agreements that protect early shareholders. If new shares are issued at a lower price, conversion terms are adjusted so earlier investors don’t lose too much value. There are two main types:

• Full Ratchet: Suppose an investor bought preferred shares at ₹10 each. Later, new shares are issued at only ₹2 each. With full-ratchet protection, the investor’s conversion price adjusts to ₹2. This means they get more shares and keep their ownership percentage. 
   
• Weighted Average:  If there were 1,000 shares at ₹10 and a new issue of 500 shares at ₹5, the weighted average might adjust the price to around ₹8 per share. 

3. Rights Issuance (Preemptive Rights)

Companies sometimes give current shareholders the first chance to buy new shares at a discount. This way, they can maintain their ownership percentage and avoid being diluted.

Do you know that in 2020, Reliance Industries raised ₹53,124 crores via rights issuance? The issue price of ₹1,257 per share was lower than the market price of ₹1,450. 

Conclusion 

Dilution reduces ownership, EPS, and control. However, strategies like anti-dilution rights, EPS reporting, and rights issues help investors protect their ownership. This way, a company can grow and raise funds whenever needed. 

Frequently Asked Questions

How is dilution different from a stock split?
A stock split increases shares but reduces the price proportionally, so ownership doesn’t change. Dilution reduces ownership and may lower per-share value.

Can dilution affect debt holders?
No, dilution mainly impacts shareholders. Debt holders receive fixed interest and principal repayment regardless of share count.

What is a secondary offering?
It’s when existing shareholders sell their shares in the market. Unlike new share issuance, it doesn’t dilute ownership.

How do convertible bonds cause dilution?
If bondholders convert bonds into shares, new equity is created, leading to dilution of existing shareholders’ percentage ownership.

How do investors check dilution risk before investing?
They review company filings like cap tables, ESOP plans, and convertible securities details to estimate possible future dilution.
 

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