The term stock dilution or share dilution refers to the devaluation of a company’s shares resulting from the company's issuing of new, additional shares. Stock dilution may affect the monetary value of shares, voting rights, stock dividends, or a combination of these.
Example of stock dilution:
A company is founded by 4 partners which each invest 25,000 Swiss francs of capital into the business. The company’s stock is made up of 100,000 shares, of which each shareholder holds 25,000 shares. So each investor owns one quarter of the business and all 4 hold equal voting rights. The original value of each share is 1 franc, to reflect the value of the invested capital.
In order to raise additional capital to develop its product, the company takes on an investor. The investor invests 200,000 francs into the business. The company issues 200,000 new shares which are given to the investor to represent their capital investment. So the company’s stock is now split into 300,000 shares instead of the original 100,000. The investor now holds over 66% of company shares. The original 4 partners now hold less than 8.4% of shares each, meaning their stock was diluted by 16.6% each.
The investor has superior voting rights because they own a larger share of the company. They also receive a larger share of dividends.
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