5 ms·

Redefining dilution

thereisnospork 8y ago
I come from a non-finance background, but does anyone else find the concept of dilution rather inane? Wouldn't it be much more intuitive and rational for all parties involved if new shares couldn't be issued but rather existed strictly as a percentage of the company which can only be bought from some previous owner(s)? Who would be initially defined at incorporation. I'm sure there is some reason the system is how it is, but I have no idea why that is the case.
- pavlov 8y ago
  If corporations couldn’t offer new stock, they’d lose access to their primary source of funds. IPOs and VC rounds wouldn’t exist, for example. The whole point of dilution is that a growing company is not a zero-sum game, and so it’s not necessary for somebody to lose their shares for somebody to get them. Instead, stock offerings allow new participants to buy into the corporation while giving existing shareholders a measure of the stock’s worth (although they may not be able to sell unless the offering is coupled with listing on a public exchange, i.e. an IPO).
  - amarant 8y ago
    but they still effectively lose part of their shares, as their stock now represent a lesser percentage of the company. It's still not a zero-sum game, as it's percentage of a (hopefully) more valuable company.that said I does seem to me that dilution is a way to sell off the same share of your company twice. or am I missing something? (I'm also not a economist)
  - friendzis 8y ago
    > If corporations couldn’t offer new stock, they’d lose access to their primary source of funds. IPOs and VC rounds wouldn’t exist, for example. Not necessarily. [Major] Shareholders could sell part of their stock and invest in company or as in OP's case not sell all issued stock right away. I think OP's point is that majority shareholders by issuing more shares dilute themselves at the expense of all shareholders, i.e. it is possible to issue more shares by diluting major shareholder 80% -> 60%, than by selling 25% of their holdings). I agree that new money could be a catalyst for further growth and increase total value held by each shareholder, but shares are also ownership and share dilution irrecoverably reduces ownership stake. I guess that was OP's point
- mbesto 8y ago
  You assume much too positively that human beings are rational. > which can only be bought from some previous owner(s)? This assumes that there are previous owners are willing to sell. Also, not all shares are created equal. For example, most stock setups (see FB) are setup so that no matter how much stock is lost or diluted by the original owners, they'll still have majority voting rights. You can probably imagine how tricky this starts to get knowing just those two things.
- trevyn 8y ago
  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.
kijin 8y ago
Founders like Mark Zuckerberg care deeply about dilution because they want to remain in complete control of the company for as long as possible. If you're like that, the percentage matters more than the absolute dollar value of your shares. Investors also often care about having the power to dictate the terms of future rounds and/or acquisitions. Dilution reduces this power, and humans are known to sacrifice a lot of good things in order to obtain and maintain power. Feeling powerless is very different from being penniless. This might explain why so many people are obsessed with percentages even at the cost of dollar values.
jbb67 8y ago
This seems to be missing something very important to me. Yes if your ownership goes from 10% to 8% but of a more valuable company you don't lose money. But presumably you were hoping the company would do well and be worth 10 times as much in the future, and your 2% loss of that future value is much more significant.

I come from a non-finance background, but does anyone else find the concept of dilution rather inane? Wouldn't it be much more intuitive and rational for all parties involved if new shares couldn't be issued but rather existed strictly as a percentage of the company which can only be bought from some previous owner(s)? Who would be initially defined at incorporation. I'm sure there is some reason the system is how it is, but I have no idea why that is the case.

pavlov 8y ago
If corporations couldn’t offer new stock, they’d lose access to their primary source of funds. IPOs and VC rounds wouldn’t exist, for example. The whole point of dilution is that a growing company is not a zero-sum game, and so it’s not necessary for somebody to lose their shares for somebody to get them. Instead, stock offerings allow new participants to buy into the corporation while giving existing shareholders a measure of the stock’s worth (although they may not be able to sell unless the offering is coupled with listing on a public exchange, i.e. an IPO).
- amarant 8y ago
  but they still effectively lose part of their shares, as their stock now represent a lesser percentage of the company. It's still not a zero-sum game, as it's percentage of a (hopefully) more valuable company.that said I does seem to me that dilution is a way to sell off the same share of your company twice. or am I missing something? (I'm also not a economist)
- friendzis 8y ago
  > If corporations couldn’t offer new stock, they’d lose access to their primary source of funds. IPOs and VC rounds wouldn’t exist, for example. Not necessarily. [Major] Shareholders could sell part of their stock and invest in company or as in OP's case not sell all issued stock right away. I think OP's point is that majority shareholders by issuing more shares dilute themselves at the expense of all shareholders, i.e. it is possible to issue more shares by diluting major shareholder 80% -> 60%, than by selling 25% of their holdings). I agree that new money could be a catalyst for further growth and increase total value held by each shareholder, but shares are also ownership and share dilution irrecoverably reduces ownership stake. I guess that was OP's point
mbesto 8y ago
You assume much too positively that human beings are rational. > which can only be bought from some previous owner(s)? This assumes that there are previous owners are willing to sell. Also, not all shares are created equal. For example, most stock setups (see FB) are setup so that no matter how much stock is lost or diluted by the original owners, they'll still have majority voting rights. You can probably imagine how tricky this starts to get knowing just those two things.
trevyn 8y ago
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.

kijin 8y ago

Founders like Mark Zuckerberg care deeply about dilution because they want to remain in complete control of the company for as long as possible. If you're like that, the percentage matters more than the absolute dollar value of your shares. Investors also often care about having the power to dictate the terms of future rounds and/or acquisitions. Dilution reduces this power, and humans are known to sacrifice a lot of good things in order to obtain and maintain power. Feeling powerless is very different from being penniless. This might explain why so many people are obsessed with percentages even at the cost of dollar values.

jbb67 8y ago

This seems to be missing something very important to me. Yes if your ownership goes from 10% to 8% but of a more valuable company you don't lose money. But presumably you were hoping the company would do well and be worth 10 times as much in the future, and your 2% loss of that future value is much more significant.