You found a business. You grow it from a tiny startup to the brink of greatness. But you need money to expand.
You get a few angel investors. They take a stake, but its still just you and a handful of people with ownership in the company...basically, everyone with shares in the company could still share an elevator ride together.
Things go well, and it's time to really blow it out. Bring in lots of cash from lots of investors. Your ownership (and the ownership of your original investors) is about to drop substantially as you issue shares to everyone else.
A massive dilution in your shareholdings is about to happen. That's the wash-out round of financing...the point where the previous investors get their shareholdings hosed with big-time dilution. Their shares get washed out by the deluge of new stock issuance.
Don't feel too badly though...those original investors usually get a bunch of cash as compensation.
See: Angel Investors.
Related or Semi-related Video
Finance: What is Dilution?77 Views
finance a la shmoop. what is dilution? ownership is a pie.
here's 100% of pie. it's divided into 20 million slices, there there you just [man holds pie]
can't see them. each is a share of ownership in the company whatever.com
well one day the CEO of whatever.com decided she wanted to buy her hated
competitor something.com for 2 million shares. then she wanted to buy her
marketing vendor sell my butt off.com for a million shares. well her stock had
been trading at 12 bucks a share for a total market valuation of 240 million
dollars .see we get that 12 times 20 million. but then after printing 3 [equation]
million more shares to buy her competitors,
well she now has 23 million slices of pie .and yes that's how it works!
companies can essentially just go to the Xerox machine and print shares of their
own stock, that they didn't formerly own. but now she has 23 million shares [printer prints shares]
outstanding and not 20 million. so at $12 a share the stock market is valuing her
company at a meaningfully higher price. 12 times 23 million is 276 million. it's
saying that the value of the three million share dilutions she took in
buying something dot-com and Sell my butt off.com [woman waves to camera]
was the difference between the 276 million in the 240 million or 36 million
bucks. but let's say the market value had stayed flat at 240 million. well now with
23 million shares out the stock is only worth 10 dollars and 43 cents a share,
instead of the previous $12 a share. in other words shares have been diluted
each share of whatever com is no longer worth as much as it used to be. that pie
isn't looking quite as appetizing now is it? [man frowns in kitchen wearing apron]
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