Capital Increase and Dilution
Definition
Companies without sufficient operating cash flow — the norm rather than the exception among smaller listed companies — raise money through the capital markets. Issuing new shares brings in fresh funds, but spreads the company's value across a greater number of shares.
A worked example
A company has 10 million shares outstanding; you own 100,000 of them, which is one per cent. If 5 million new shares are issued, there are now 15 million shares in total — your 100,000 shares represent only around 0.67 per cent. Your stake has shrunk by a third, even though you have sold nothing.
Not all dilution is bad
What matters is what the money is used for. If it funds a trial that could significantly increase the company's value, then a smaller slice of a larger pie may well be worth more. If the money simply keeps the lights on for a few more months, it only delays the problem.
Warrants and options — the hidden dilution
Alongside the shares already in circulation, there are often options and warrants that can be converted into shares at a later date. These do not appear in the basic share count, but they can substantially increase future dilution. It is always worth looking at the fully diluted share count.
Common mistakes
- Looking only at the shares currently outstanding and overlooking options and warrants.
- Treating a capital increase priced at a significant discount to the market price as a neutral event — the discount is a signal about demand.
- Treating dilution and a falling share price as the same thing: the two are related, but they are not identical.
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Educational content only, not investment advice. Small caps are highly speculative and total loss is possible. All information without warranty.