Equity Dilution

What is Equity Dilution?

Equity Dilution is a method used by the companies to raise capital for their business and projects by offering ownership in exchange. This process, therefore, reduces (dilutes) the ownership of existing owners.

Formula

Equity Dilution

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Source: Equity Dilution (wallstreetmojo.com)

Equity Dilution = (Existing Share – New Share) / Existing Share ×100

Examples

You can download this Dilution Formula Excel Template here – Dilution Formula Excel Template

Example #1

There is a partnership firm of lawyers. In that firm, there are four partners, name A, B, C and D. Partners have equal profit sharing ratio, i.e. 25% each. Now, the firm wants to introduce a new partner name E. After the admission of E in the firm, the partnership deed was changed, and now, the new profit sharing ratio is 20% each. Calculate equity dilution.

Solution 

Below is the given information –

Dilution Formula Example 1

Calculation of change in the ratio can be done as follows,

Example 1.1
  • =(25% – 20%) / 25%*100%

Change in Ratio will be –

Dilution Formula Example 1.2
  • Change in Ratio = 20%

Similarly, we can calculate the change in ratio for old partners –

Example 1.3

Explanation

A, B, C & D shares an equal ratio in partnership, i.e. 25% each partner. Now partnership firm has brought a new partner in the firm. Because of his admission to a firm, the existing partners have to sacrifice 20% of their existing ratios. Now each partner shares is 20% in profit & loss of the firm.

Example #2

RHS Inc. is a private company, and all the shares have been held by its promoters only. Promoters of the company decide to list RHS Inc. in the stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more. Promoters want to issue an initial public offer to the public. Promoters are holding 70000 million common stocks at $1 each. Promoters want to issue 33600 million common stocks in the initial public offer, and they will hold remaining stock. Calculate dilution of ownership.

Solution

Below is the given information –

Example 2

Calculation of after dilution holding of promoters –

Dilution Formula Example 2.1
  • =7000 – 33600
  • =36400

Calculation of Dilution of Ownership can be done as follows –

Example 2.2
  • =(70000 – 33600) / 7000*100%

Dilution of Ownership will be –

Dilution Formula Example 2.3
  • =52%

Calculation of New Holdings

Dilution Formula Example 2.4
  • =100% – 52%
  • =8%

Explanation

Promoters of RHS Inc. wants to make an initial public offer. They are offering 33600 million stocks in initial public offer out of 70000 million stocks. Due to this offer, their ownership will be diluted. Before the offer, they are 100% owner of the company, but after the offer, they will be the 52%-part owner of a company, 48% of the stock will be held by the public and few financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more. Through the initial public offer, they have diluted their ownership.

Example #3

HNR Inc. is a public corporation. The company is listed on the US stock exchange (NYSE). The company has common equity of 90000 million stocks. The company has 40000 million convertible preference shares. Also, the company wants to issue follow on public offer (FPO) to raise funds from the public. The company is issuing 30000 million stocks in follow on public offer. The company had issued 20,000 million convertible debentures to the public 5 years ago. These debentures will need to be converted into common stock in the current year. One shareholder of the company is currently holding 8100 million stocks. Calculate equity dilution.

Solution

Below is the given information –

Dilution Formula Example 3

Current Holding

Dilution Formula Example 3.1
  • =8100/90000
  • =9%

Calculation of Common Stock & Current holding after conversion of preference share

Example 3.2
  • =90000 + 40000
  • Common Stock = 130000
  • =8100/130000
  • Current Holding = 6.23%

Calculation of Common Stock & Current holding after conversion of debentures

Dilution Formula Example 3.3
  • =130000 + 20000
  • Common Stock = 150000
  • =8100/150000
  • Current Holding = 5.40%

Calculation of Common Stock & Current holding after follow on pubic offer –

Dilution Formula Example 3.4
  • =150000 + 30000
  • Common Stock = 180000
  • =8100/180000
  • Current Holding = 4.50%

Calculation of Dilution of Holding after Conversion of Preference Shares –

Example 3.5
  • =(9% – 6.23%) / 9%*100%

Dilution of Holding after Conversion of Preference Shares –

Example 3.6
  • =30.77%

Calculation of Dilution of Holding after Conversion of Debentures –

Dilution Formula Example 3.7
  • =(6.23% – 5.40) / 6.23%*100%
  • =13.33% 

Calculation of Equity Dilution after Follow on Public Offer –

Dilution Formula Example 3.8
  • =(5.40% – 4.50%) / 5.40%*100%
  • =16.7%

Recommended Articles

This has been a guide to Equity Dilution and its meaning. Here we discuss its formula and calculations along with practical examples. You can learn more from the following articles –

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