Eli5: When companies go public and sell x amount of shares, how can they sell more later and dilute shareholders? Does the company still own a piece of itself to sell later?

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Eli5: When companies go public and sell x amount of shares, how can they sell more later and dilute shareholders? Does the company still own a piece of itself to sell later?

In: Economics

2 Answers

Anonymous 0 Comments

Listed companies will normally raise new capital (and issue new shares) via a rights issue. This will raise money from existing shareholders and they will not be diluted, e.g. a 1 for 10 issue where you are entitled to 1 new share for every 10 shares you hold.  

There are other mechanisms like private placements, new investors coming on board etc, but rights issues achieve both raising capital whilst not diluting existing investors (generally). 

Anonymous 0 Comments

If a company creates more stock to sell, yes, you are correct that that dilutes people with existing shares.

That’s why companies are *very* resistant to doing exactly that.

Sometimes shareholders are okay with it–if shares are being created and sold to pay for an ambitious expansion, many will hold on to it because they assume the price will increase beyond what it *would* have been.

But often, they’re not–shareholders view it as an intentional weakening of both their value and their voting rights.

There *is* a “stock split” which is generally reserved for when the price of the stock gets too high. In this case, though, they simply double the shares (or triple, or whatever) so everyone retains the same percentage as before and doesn’t hurt anyone. (They do this to make it easier to buy/sell stock–if a single stock is worth $10,000 it’s very hard to buy and sell, so they just make it ten shares worth $1000 each.)

There are some mechanisms in place that allow new shares to be created, but they’re very particular. One is to allow existing shareholders to buy new stock at a discount to “make up” for the dilution.

As for whether or not a company still owns a piece of itself–it all depends. Most companies will retain a controlling interest (51%) or at least a major chunk of it.

Corporations are much, much more likely to do stock buybacks (to then sell at a later date) instead of new shares. But there *are* strategic reasons to issue more stock, especially for newer companies where the ownership pool is small and there is an expectation that growth will trump value for a while.