Equity dilution refers to the cut down in the stock holding of shareholders in relative terms of a particular company, usually a startup, whenever an offering for new shares is made whether through an IPO, FPO or private equity.
The valuation of a company increases whenever more money comes in as a form of investment through an external entity.
However, the total number of shares issued of that particular company increases while the number of shares held by the initial investors remain the same, thus their equity holdings in the company reduces in percentage terms.
Suppose a company has issued 100 shares to 100 unique shareholders. Each shareholder owns 1% of the company. If the company then has a secondary offering and issues 100 new shares to 100 more unique shareholders, each shareholder will only own 0.5% of the company. The smaller ownership percentage also diminishes each investor’s voting power.
Share dilution may be imminent any time a company needs additional capital. The potential upside of share dilution is that the additional capital the company receives from issuing additional shares can improve the company’s profitability and the value of its stock.
This reduction is termed as equity dilution.
Source: Investopedia / Economics Times