What is Dilution?

Dilution is the reduction in the ownership interest of an existing shareholder when a corporation issues more shares of stock. Even though the same amount of stock is held by the investor, its ownership interest becomes diluted because there are now more shares outstanding.

Common Causes of Dilution

Dilution of stocks within a business will usually come down to a few basic occurrences:

• New financing rounds: Raising money by creating new shares and exchanging them with the capital providers
• Exercise of stock options: Creation of new shares by exercising stock options by company employees
• Conversions of convertible securities: Conversions of convertible debt into stocks on a trigger date
• Exercising of warrants: Purchasing of stocks at a fixed price through exercising the warrant
• Secondary stock issuance: Issuance of new stocks by a company after going public

With each of those occurrences, the number of outstanding stocks increases, and hence reduces the percentage of ownership of any shareholder before that transaction.

What is Dilutive?

Dilutive means a situation where an action or deal lowers the ownership percentage of existing shareholders. This is because the issuance of additional stock to raise money becomes dilutive financing if such an action lowers the ownership percentage of existing shareholders.

How is Dilution Calculated?

Here is a simple way to calculate the ownership percentage. 

For example:

• Existing shareholder’s shares = 1,000
• New shares issued = 500
• Total shares after issuance = 1,500

Ownership after dilution = 1,000 ÷ 1,500 × 100 = 66.67%

If the shareholder originally owned 100% of the company, the ownership percentage has been diluted to 66.67%.

The percentage-point reduction is:

100% − 66.67% = 33.33 percentage points

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