What is stock dilution? Effects when shares are diluted

As an important part of corporate finance activities, issuing new shares is often an important strategy to increase capital, expand business and promote development. This is considered an action to dilute the company’s shares. While there are clear business benefits, it is also important to pay attention to this fact. The article below will answer what stock dilution is, why it is important and how it affects investors and businesses.

I. What is stock dilution?

Stock dilution – in English, stock dilution or equity dilution is the process of reducing the ownership ratio of current shareholders in a business when new shares are issued.

At this time, the total number of shares issued on the stock market will increase, the ownership ratio of shareholders will decrease, corresponding to benefits such as profits per share, voting rights, and some other benefits. Other benefits will also decrease.

II. Example of stock dilution

For example, you are one of the shareholders of company A. Initially, when newly established, company A issued a total of 1 million shares, you are a shareholder who owns 100,000 shares, equivalent to 10% of the total. A’s shares

Company A decided to conduct a new round of capital raising to increase capital for business expansion, so they issued 500,000 new shares to new investors.

After the capital call is completed, the total number of shares of A is 1.5 million shares. At that time, if you do not buy more shares but still own the old shares, your ownership ratio in company A drops to only 6.67% (100,000 shares/1.5 million shares).

In this case stock dilution has occurred, your ownership ratio in company A has decreased due to the increase in new shares.

III. Causes of stock dilution

The reasons for stock dilution can occur in many cases:

1. Issuing new shares

Businesses can issue new shares to new investors or as rewards to employees. This leads to sharing of benefits and power between existing shareholders and new ones.

Forms of new share issuance include:

Offering individual shares – to strategic shareholders or partners of the business. These buyers are all identified and included in the list in advance by the business.

Offering shares to the public – the number of shares sold is very large, not predetermined. This stock dilution is intended to mobilize a large amount of investment capital.

Offering shares to existing shareholders – each shareholder will be able to buy a number of shares equivalent to their current ownership ratio. If all shareholders simultaneously buy shares, their ownership ratio will remain the same. However, if there are shareholders who do not buy, that ownership ratio will change, and stock dilution occurs. .

Take newly issued shares as rewards for company employees – the purpose is to motivate and retain workers.

2. Convertible bonds

In some cases, businesses can issue bonds convertible into shares. Some bondholders want to convert from bonds to stocks, which means the business’s debt is reduced, so many businesses issue convertible bonds to convert debt into capital. When bonds are converted, stock dilution occurs, the ownership ratio of current shareholders will decrease.

3. Restructuring the business

When a business undergoes restructuring such as expanding scale, implementing M&A deals… there may be a redistribution of shares or issuance of new shares, leading to stock dilution.

IV. Impact of stock dilution on stock code

1. Impact of stock dilution on businesses

Issuing new shares will help businesses increase the number of existing shareholders, reduce the rights of founding shareholders, and they may even lose control of the business;

The capital structure is also changed, because equity capital increases, debt from bonds decreases, if convertible shares are issued;

When stock dilution occurs, financial indicators such as return on share ratio, return on equity ratio, and debt-to-equity ratio all change;

Stock dilution also increases pressure on the business’s leadership, they are forced to have a strategy to generate profits equivalent to the increased capital;

Looking at it positively, stock dilution gives businesses the opportunity to expand scale, increase production efficiency, and increase revenue and profits. At the same time, issuing bonus shares to employees also increases their motivation to work, which is a way to retain and increase their commitment to the company in the future.

2. Impact of stock dilution on the company’s shareholders

Share dilution causes shareholders’ ownership ratio to decrease compared to the original, if they do not buy new shares. This also affects their direct rights, such as voting rights, dividend profits, basic interest rate… This is a disadvantage for shareholders in general.

3. Impact of stock dilution on the stock market

Businesses issuing more shares will help increase the supply of shares in the market but also put pressure on selling demand. In addition, some shareholders are afraid of stock dilution affecting their rights, so they continuously sell, causing the number of outstanding shares to increase, while the demand for repurchases cannot be met in time, leading to imbalance in the stock market.

On the other hand, the decrease in attractiveness of a business’s valuation index causes many investors to feel hesitant when accessing the company’s own shares, causing a significant impact on the market if as this situation persists.

V. How to ensure benefits when stock dilution occurs

First, it may be required that the business achieve a growth rate equivalent to the percentage of diluted shares that shareholders are holding.

Second, shareholders can request the enterprise to apply provisions to maintain ownership ratio, based on Article 115 of the Enterprise Law 2020. This regulation helps shareholders limit stock dilution as well as Ownership ratio is reduced, thereby protecting your interests after a stock dilution event occurs.

Thus, TOPI has provided you with some information about the stock dilution event. Stock dilution is not always bad, it also brings benefits to businesses, for example, using proceeds from capital calls to invest in business expansion and improving production capacity. , or repay debt. Understanding stock dilution helps you protect your shareholder interests.