Dilution refers to the decrease in ownership percentage of existing shareholders when a company authorises new shares.
These shares may be authorised and issued to investors to raise capital for the business, or as part of the company’s option scheme.
As new shares are issued, the total number of shares in the company has increased, which decreases existing shareholders’ ownership percentage – effectively diluting their shares.
Dilution is not to be confused with a subdivision. Dilution occurs when a company creates new shares, which reduces the ownership percentage of existing shareholders. Whereas a subdivision divides existing shares into smaller pieces to create more shares, but everyone’s ownership percentage remains the same.
How is dilution calculated?
While it’s easy to see dilution as creating X amount of new shares, most shareholders want to know what percentage they’re being diluted by.
Dilution % can be calculated using the following formula:
Dilution % = (New Shares Issued ÷ (Existing Shares + New Shares Issued)) x 100
For example, if a company has 1,000,000 existing shares and issues 200,000 new shares, the dilution percentage would be:
(200,000 ÷ (1,000,000 + 200,000)) x 100 = 16.67%
The higher the percentage, the more diluted the existing shareholders' ownership becomes.
Use our shared ownership calculator to see how the company’s ownership will change after new shareholders are added.
What other impacts does dilution have on shareholders?
When considering a new share authorisation, it’s important to understand the impact it can have on existing shareholders.
Of course, it may be necessary to secure funding, but understanding dilution can help you strike a balance between keeping existing shareholders happy and managing the long-term success of the company.
As well as a reduced ownership percentage, here’s what else to look out for:
- Earnings per share (EPS): As the number of shares increases, the company's earnings get distributed over a larger number of shares. This will change the amount of dividends or capital each shareholder receives.
- Voting power: A diluted shareholding means voting power is also reduced. If you have shareholders that are key decision-makers, you may want to factor their diluted ownership percentage into the share authorisation.
Deciding the size of share authorisation/dilution percentage is a commercial decision that will require board – and often shareholders’ – resolutions. But professional financial and legal advice should be sought if in any doubt, or if you have specific questions.
Some key things to consider when thinking of dilution is the company’s financial needs, investment opportunities, growth prospects, market conditions, and of course, alignment with existing shareholders.
Authorising shares on Vestd
If you’re going for an investment round, you can get the wheels in motion by authorising a share pool on Vestd so the shares are ready to issue once funding is secured.
Similarly, you can create an option pool ready to grant EMI or unapproved options to your recipients.
Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'