Stock dilution is a general term that results from the issue of additional common shares by a company. This increase in common shares of a stock can result from a secondary market offering, employees exercising stock options, or by conversion of convertible bonds, preferred shares or warrants into stock. This dilution can shift fundamental positions of the stock such as ownership percentage, voting control, earnings per share, or the value of individual shares. A broader definition specifies dilution as any event that reduces an investor's stock price below the initial purchase price.
Control dilution describes the reduction in ownership percentage or loss of a controlling share of an investment's stock. Many venture capital contracts contain an anti-dilution provision in favor of the original investors, to protect their equity investments. One way to raise new equity without diluting voting control is to give warrants to all the existing shareholders equally. They can choose to put more money in the company, or else lose ownership percentage. When employee options threaten to dilute the ownership of a control group, the company can use cash to buy back the shares issued.
The measurement of this percent dilution is made at a point in time. It will change as market values change, and cannot be interpreted as a measure of the impact of dilutions.
1. Presume that all convertible securities are convertible at the date.
2. Add up the number of new shares that will be issued as a result.
3. Add up the proceeds that would be received on these conversions and issues (The reduction of debt is a 'proceed').
4. Divide the total proceeds by the current market price of the stock to determine the number of shares the proceeds can buyback.
5. Subtract the number bought-back from the new shares originally issued
6. Divide the net increase in shares by the starting # shares outstanding.
