What is equity dilution?

When a company grows, it needs to look further finance and increase capital. This requires issuing new shares so that new shareholders can buy and invest. It may also be the case that the former investors who already own the old shares buy a certain amount of the new shares and thus the percentage of ownership does not decrease. However, if old investors do not take this action and new investors enter, the former will see that the percentage of shares will decrease as there are more shares available than before. This decrease in ownership of the shares is called "dilution", since the value is diluted, it decreases.

When does a capital dilution occur?

The increase in the number of shares can occur with an offer in the primary market, by employees who own shares or by issuance or conversion of bonds and preferences.

Capital dilution is a useful tool that is used in situations of company insolvency, if a company debt refinancing it has not produced the desired effect. With this tool, the aim is to transform part of the debt into shares.

Effects of capital dilution

The dilutive effect on the shares can produce a change in the percentage of participation, which leads to a change in voting control, earnings and the value of those shares. You could say that the new shareholders they are going to contribute less than what the old shareholders had.

How can the dilutive effect on former shareholders be avoided? The most appropriate resource that former shareholders can turn to is that of subscription rights, rights that increase the value of the shares in the event of a capital increase.

Leave a Comment