Basically they create new stock to issue out, which increases the total number of stock in the company in turn diluting the percentage of stock you own
The total stock of a company, yes. Your particular share - not necessarily. You could get diluted to pretty much nothing if the company chooses to issue more shares.
Shareholders can usually push back via voting, but depending on the way the company is setup they could still successfully dilute smaller shareholders.
Could someone explain dilution like I'm 5? I haven't researched it much, but I always assumed additional shares would be split between existing shareholders.
For example, let's say there are 10 shares in a company, and I own 1. We decide we need 100 shares in total. Dilution makes me think 90 new shares are issued, and I still own 1, bringing my ownership down from 10% to 1%. However, common sense tells me if you issue 90 new shares, since I already own 10%, that means 10% of the new shares should belong to me. So, I now have 1 + 9, or 10/100 shares, remaining at 10% ownership.
You own shares but the total number of shares is not fixed.
Say you own 20,000 shares out of 100,000 shares and you own 20% of the company, they issue another 9,900,000 shares 10 min befores selling the company and you now own 0.2%.
Right. The remaining shareholders own a larger percentage of a company that now owns less cash.
Say the only thing my company owns is a bank account with $100 in it. There are 5 shares outstanding worth $20 each. The company buys back one share for $20, so now there are 4 shares outstanding in a company that owns $80.
A new investor brings money into the business to "purchase" those newly printed shares, so diluting previous investors' percentage of ownership doesn't necessarily change their material position unless there are more strings attached to the investment.
For example, if an enterprise was worth $100M before investment and then there's a new investor that brings in $100M, the new investor owns 50% of a $200M pie and the previous investors combine to own 50% of $200M as opposed to 100% of $100M.
They issue new shares. Let's say each shareholder has 100 shares, they might issue 10,000 new shares to sell which means your shareholding gets massively diluted unless you buy a large portion of the new shares.
Creating shares, regardless of changes in company value, dilutes percentage ownership of previous investors. I think your definition of "dilution" isn't capturing this aspect of GP's comment.
This doesn't sound like what happened in the case here, but dilution can happen due to reasonable funding rounds. If you own 1 share out of 100 and then the company decides to go to some investors and raise $10 million, they might give those investors 50 shares, meaning the company now has 150 shares, the new investors own a third of the company, and you own 2/3 of a percent of the company instead of 1 percent. Where this gets messy is if shenanigans are used to dilute particular shareholders (e.g., after some event you now own 0.001% and someone else's portion is unchanged) or other such things.
Edit: I should add that even publicly traded companies do this, issuing more shares and diluting current shareholders to raise capital.
It’s dilution at the same time as money is literally injected into the company. Say a company valued at $100M issues 10% more shares at the same time as it receives a $10M investment (10% of its value), thus becoming a $110M company. In theory, the existing shares lose no value in the process: $110M * (100%/110%) = $100M
Of course, there are always disagreements about valuation and strategy.
The fundamental mechanism is that new investment is met by issuing new shares. If you hold options on a constant number of shares, and the number of shares into which ownership is divided goes up, then your fractional share of ownership goes down.
I looked up if a company can do the opposite - basically poof additional shares into existence and sell them - and found out they basically can and it's called stock dilution.
How is that legal? It doesn't make sense to me that if a share is worth x% of a company that said company can just decide "Nah, you actually now only own half of that" and sell more shares.
Fake edit: I googled "how is stock dilution legal" and found this [0] which explained it well and now it makes sense to me. The diluted stock might be a smaller % ownership, but since the company gained value because of money coming in, the dollar value of the shares stays the same.
> Then why is it, one year later (and more stock has been issued/other investors have come in), I have less than 10%?
Because other stock has been issued.
Companies can sell "new stock" or "old stock". Selling new stock dillutes. Selling old stock doesn't.
Suppose that you own 20 out of 200 shares. If the company sells 100 of those 200 shares, you still own 10% because the number of shares hasn't changed. If the company creates 100 and sells new shares, you now own 6.66% because the number of shares has changed to 300.
> the number of fully-diluted shares (to calculate your ownership)
This is something I've always been confused about. Suppose there are 100M fully diluted shares and you as an employee are granted (and vest) 20,000 shares, so you have 0.02% of the total shares. And suppose the company has a private post-money valuation of $10B and then IPOs to a stable $10B market cap. So you would think (0.02%)×($10B) = $2M payout.
But! This doesn't include the fact that during an IPO, the company creates additional shares, right? And none of these new shares are sold directly to the public; they are first sold to banks or other prioritized buyers, and only then is the public able to purchase shares from anyone who owns them. Would this not decrease the employee payout? Assume the company creates 100M new shares for the IPO at a price of $50 per share. Now the banks pay the company (100M)×($50) = $5B for those shares, and then they sell them the next day on the open market. The final share price for the day would now have to be $10B/200M = $50 to have a market cap that is equivalent to the private valuation of $10B. But that means the employee's payout is actually $1M, not $2M.
Is my understanding of this correct, or am I missing something? It seems like you can't just take your percentage of private shares and multiply it by the private valuation to estimate your IPO payout.
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