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Dilution in Capital raises

Fresh Knowledge

Last updated 3 years ago

Dilution in Capital raises

The effect of capital raises on dilution is a common concern of existing shareholders as it affects their ownership percentage. Each type of capital raise is affected by dilution differently and there are advantages and disadvantages to each depending on the situation.

Dilution in capital raises

Dilution is the change in ownership percentage that occurs when new shares are issued which increases the number of total shares, thereby decreasing the effective ownership percentage of each existing holder. 

For example - A company has 100,000 total shares on issue and then issues 10,000 new shares as part of a capital raise. The existing shareholders would have their ownership percentage diluted by 10% if they did not participate. A shareholder that had a 10% stake in the company prior to the raise would now be diluted to 9% = 10% x (100%- 10%).

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Dilution in a placement

During a placement, new shares are issued and offered to qualifying sophisticated and professional investors. Existing shareholders are affected by dilution if they do not participate in the capital raise. 

As retail investors can’t participate in placements, they will always see their shareholding diluted. There is no limit on the maximum an individual can take up in a placement so the effect of dilution on existing shareholders participating depends on their allocation.

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Dilution in a Shareholder Purchase Plan

Shareholder Purchase Plan (SPPs) put larger shareholders at a greater risk of dilution, as $30,000 is the maximum subscription amount irrespective of one’s existing shareholding amount. For smaller shareholders this presents an opportunity to increase their ownership percentage, but larger shareholders may be unable to offset the dilution of the capital raise. 

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Dilution in Entitlement Offers 

Entitlement Offers give each shareholder the opportunity to subscribe for an amount proportional to their ownership percentage. For example, if a company is raising $10m and an existing shareholder owns 1% of the company prior to the launch of the capital raise, then they will be able to subscribe for $100k under the offer. 

This means that if all investors participated to their full capacity there would be no dilution, however, it can also put smaller shareholders at risk if they do not take up their full holdings and larger holders do. 

Many companies will conduct a Share Purchase Plan or an Entitlement Offer in conjunction with a Placement so existing shareholders get an opportunity to participate.

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