How does a company add more shares? ronny1976

#1
Sorry, bit of a noob question but say a company already has one million shares which is 20% of the company. The company is valued at $50 million dollars so each share is trading at $10.



If the company decides to raise more money by issuing more shares, then it would dilute existing shareholders investment in that company. So what determines whether a company can offer more shares or how many it can offer?



TIA

#2
They are free to do it whenever they want. Of course existing investors tend not to be very happy about their holdings being diluted so they may try to placate them by offering some of the new shares to existing investors at a discount.



If they do it too much it will not only annoy investors but also be taken as a sign the company is in trouble and their share price will crash. Investors prefer there to be a valid reason for wanting the cash such as funding a takeover or moving into new markets.

#4



They are free to do it whenever they want. Of course existing investors tend not to be very happy about their holdings being diluted so they may try to placate them by offering some of the new shares to existing investors at a discount.



If they do it too much it will not only annoy investors but also be taken as a sign the company is in trouble and their share price will crash. Investors prefer there to be a valid reason for wanting the cash such as funding a takeover or moving into new markets.
Originally posted by Reaper


But say if they issue another 1 million shares by giving up another 20% of their company. If the value of the company doesn't change then the shares wouldn't be diluted, would they?



I'm not sure why they are referred to as being diluted?

#5



Sorry, bit of a noob question but say a company already has one million shares which is 20% of the company. The company is valued at $50 million dollars so each share is trading at $10.



If the company decides to raise more money by issuing more shares, then it would dilute existing shareholders investment in that company. So what determines whether a company can offer more shares or how many it can offer?



TIA
Originally posted by ronny1976


No, you have it wrong. The total shares in issue is 100% of the company. Adding more will dilute the existing ones. The total is 100%, different people may own different percentages as your example of 20% but the 80% remaining has to be held by someone.

#7



But say if they issue another 1 million shares by giving up another 20% of their company. If the value of the company doesn't change then the shares wouldn't be diluted, would they?
Originally posted by techno79


Previously, if I had 1 million shares I would own a fifth of its assets and future profits for ever and ever. If they issue 1 million more shares and get £10m in the bank account, I will only own a sixth of the company instead of a fifth. My holding has been watered down.



Sure, the fact it has £10m in the bank might allow it to do things it couldn't have done before, and enhance its future prospects. But whatever those prospects are, I now only get a sixth of them instead of a fifth of them, from now until the the end of time, and I share any assets on a winding-up, between more shareholders.



Also, I want to be able to give instructions to my board of directors in a general meeting, like, "yes i approve this merger transaction" or "no, I don't approve the directors' remuneration". If the director has just issued 10 million more shares to his mates who are sympathetic to the ideas of another major shareholder, then my diluted vote is now too weak to make a difference and we get railroaded into doing stupid things that serve the interests of the new big investor with a loud mouth and dumb ideas who wants to get his way.



So, like adding more water to some orange squash, my ownership of assets and income and my control of the company has been diluted. The share price of the new issue (and therefore the amount of enhancement to the company's cash or other assets and its prospects) has to be "worth it" for me to like the result, which may require issuing shares above (rather than at, or below) today's share price.



In most companies the ownership of ordinary shares comes with pre-emption rights, i.e. the articles of association prohibit new shares being offered without giving existing holders an opportunity to participate pro rata on the same terms. However, applying those rights can be time consuming and expensive when you have 500,000 shareholders and you want to raise 5 million, as you'd have to allow some people to put a few pence to participate proportionately to their shareholding in a "on average, we need a tenner each" opportunity.



So, often the directors have been granted (by a vote of shareholders) the ongoing ability to issue up to £x or up to y% of new capital while disapplying the pre emption rights, for example to get a new investor on board, or raise money quickly in a placing to fund a time-critical deal, to make awards under executive incentive schemes, create convertible loan agreements etc. Those permissions given to the directors can expire and usually need renewing from time to time. Blanket permission to buy back or issue more shares up to x% of a total can be an integral part of ongoing discount or premium control mechanism in an investment trust for example.



I could go on but you get the gist.




I'm not sure why they are referred to as being diluted?


Because your rights have been watered down, even if the company overall got a bit more valuable in the short term because of the extra cash in the bank. What if the new cash in the bank doesn't, on average, produce the same returns as the company's existing stores of value such as real assets, premises, intellectual property and licenses, pool of awesome staff? I'd rather own a fifth of a big profit growth story than a sixth of a lossmaker thanks very much.



Obviously in some cases it works the other way and is better to have a sixth of a billion than a fifth of a million, so you would welcome the dilution in some mergers or fundraisings where you think they might be returns-enhancing.

#8
There are rules on issuing shares in company's articles of association and in the Companies Act.



The board of directors of a private company which has only one class of shares can issue new shares, on the basis of a board of directors approval.



A private company which has more than one class of shares can issue new shares, but requires shareholder approval (or a enabling provision in the company's articles of association).



Companies which are listed on a stock exchange are also subject to stock exchange rules which limit their ability to issue new shares. By convention listed companies typically get a standing authority from their shareholders at the annual general meeting to issue a limited number of new shares during the following year, but a specific shareholder approval is required to do large share issues.

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