How does a company start with say 100 shares and value gets “crammed” down with more investment? If one party has five of those shares, won’t they always have the five shares and new investors get shares from some of the other 95? Are there shares that cannot get diluted? Golden shares or?
In: Economics
Is it the “value” that gets crammed down or do the actual number of shares you own do?
Dilution happens when new shares are issued. For example, say there’s an IPO of 100 shares, but then later on the company decides to give employees stock options as a benefit and 5 employees get 10 shares each. The company could choose to create new stock to give to their employees, increasing the total number of shares to 150 and diluting them.
[This article](https://www.linkedin.com/pulse/how-issue-new-shares-step-by-step-guide-fareyaaraoui?utm_source=share&utm_medium=member_android&utm_campaign=share_via) gives a pretty decent and basic overview to answer your questions.
In short, it’s fairly complicated, layered, and nuanced.
You and your friends agree to go to a birthday party and will get 1/8th of the cake each. The parents reserved half the cake for themselves later to keep in the fridge and eat throughout the week.
Suddenly more people show up (issuing more stocks) and so the parents decide to give up some of their reserved cake to the new arrivals.
This causes more “supply” and suddenly your 1/8th share of the cake seems less special with more people getting cake. Where you could’ve traded it for two cool car toys you might only get one car toy and a sticker now since it’s less rare. You just know Jimmy will get a slice himself and offload it to the first cool sticker he sees.
There’s a lot to this question, but I’ll give an example that I hope helps explain the concept and isn’t too not-ELI5…
Suppose you start a company with a partner. You split the ownership evenly: she gets 100 shares of stock, you get 100. And then you bring on an investor: for $1M, you both agree to sell 20 shares to the investor. After this sale, investor has 40 (worth the $1M they paid for it, so each share is worth $25,000) you and your partner both have 80 (worth 80 times $25k = $2M). So the company is worth a total of $5M with 200 shares outstanding.
But then you and your partner have a major disagreement about the future of the company. She wants to go in one direction, you in another. And the investor agrees with her. You take a vote: their 120 shares outweighs your 80, and she becomes the new CEO and you’re fired. You keep your stock (worth $2M) but you’re not on the board of directors anymore.
The new board then votes to create more stock, literally out of thin air. They create 999,800 new shares and split it between them. You get none.
There are now 1 million shares of stock outstanding, but the *overall value of the company hasn’t changed* and remains the same $5M. So now each share of stock is worth only $5, not $25,000 anymore. Your original 80 shares aren’t worth $2M anymore, your ownership has been “diluted” and now your shares are worth only $400. Sorry that happened to you.
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