Dilution definition
/What is Dilution in Accounting?
Dilution is the reduction of a shareholder's ownership percentage that is caused by the issuance of additional shares. This is a primary concern when a business is evaluating whether to raise funds by selling stock. It is a particular concern in a closely-held organization, where the current shareholders control the business and do not want to lose control to new shareholders.
What Cause Dilution to Occur?
Dilution occurs when more shares are added to the pool of outstanding shares, which spreads out the ownership and typically lowers the value of each share. Here are some common causes of dilution:
New stock issuances. If a company issues additional shares of stock, each existing shareholder's ownership percentage decreases because the total number of shares has increased.
Convertible securities. Certain securities, like convertible bonds or preferred shares, can be converted into common stock. When holders of these securities choose to convert, the common shares increase, diluting existing shareholders' ownership.
Employee stock options. When employees exercise stock options, new shares are issued, which can dilute the existing shareholders' stake.
Secondary offerings: In cases where the company sells more shares in a secondary offering, the increased number of shares in circulation dilutes existing shareholders.
Example of Dilution
As an example of dilution, a shareholder owns 1,000 shares of a company's stock, which is 10% of the 10,000 total shares outstanding. If the company issues an additional 5,000 shares, the shareholder's ownership percentage will have been diluted to 6.66%. This could have a significant negative impact on the shareholder’s ability to influence the corporation.