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A dilution of ownership is a process that involves the decrease of the fractional ownership that is enjoyed by shareholders of a given company. This reduction in the value of each individual share takes place when the company chooses to issue additional shares for purchase. A dilution of ownership can also take place due to the conversion of one security into another form, such as the conversion of preferred stock to common stock.
The decision to initiate a dilution of ownership is not something that a company does without careful consideration. Usually, the investigation into the possibility of issuing additional shares begins well before any action is taken. If the idea is determined to be in the best interests of the future operations of the company, an escalation process is normally implemented. The structure of the implementation must be in compliance with the bylaws and other founding documents of the company. This means that if any amendments must be made to those documents, they must be approved and registered before the dilution of ownership and the accompanying issuance of additional shares of stock takes place.
While this dilution of ownership may appear to be of more benefit to the company than to the individual shareholder, this is not necessarily the case. The offering of additional shares may in fact be a sign that the company is preparing to experience a period of rapid growth. When this is the case, the market price for each unit of stock has an excellent chance of increasing significantly. As a result, the shareholders have the chance to acquire additional shares and may soon see the overall worth of their investment in the company increase substantially.
The benefits of a dilution of ownership to a company are more readily apparent. By issuing additional shares of stock, the company is able to derive the most benefit from the capital increase that probably generated interest in the dilution process. In the short term, it may mean that the company can make better use of retained earnings. Over the long term, a dilution of ownership may position the company for expansion opportunities that would not have been possible otherwise.