First see dilution. Recap: dilution is bad. If you have a nice glass of lemonade and put a bunch of ice in it, eventually the lemonade will start to get watery...a.k.a. diluted. (Science!) If you own 50% of the shares of a company with 1 million shares outstanding and the company issues 1 million more shares, you'll own only 25% of the company. (Finance!)

Consider dilution from the eyes of an entrepreneur: the eventual goal in any company is to create wealth for shareholders. In the beginning, the founder owns all of the "wealth" or at least the shares in the company. Over time, that founder gives away pieces of the company in the form of shares to investors (in exchange for money). The problem is that the more shares the founder hands over, the less of her own company she owns.

An anti-dilutive act is anything the founder does to stop this problem. For example, she might buy back some of her own shares. Example: Some companies are anti-dilutive from the start, especially if they don't need a ton of money to get started. Yahoo! required only a little over $1 million of total capital until it reached break even. It chose to take on more capital because it believed that the dilution was worth the incremental capital raised so that it could take advantage of market opportunities. eBay was about the same.

The great fortunes of the Internet era were made in part because the founders suffered so little dilution that, at the end, they had tens of billions of dollars of wealth via their large percentage ownership stakes in the companies they founded.

Related or Semi-related Video

Finance: What Are Shares Outstanding?268 Views

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Finance a la shmoop what are shares outstanding Okay first

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things first this is not a qualitative assessment of shares

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shares maybe bad awful mediocre good or even outstanding but

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that's not what this term refers to it also doesn't

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mean that they're you know out standing in the ring

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paying dividends in the way that they don't do that

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Sorry won't sing again Alright rather shares outstanding is a

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technical term that reflects how many pieces make up the

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sum total of the ownership pie of a company So

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here is what baby's first chainsaw dot com looks like

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it has forty million slices and is currently trading for

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fifteen bucks a slice while new toddlers were so into

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mechanical power tools or how sick and twisted the writers

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it's from up Are you been here anyway If you

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didn't catch the cleverness here a slice equals a share

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so the company has forty million shares outstanding They're trading

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at fifteen bucks age and that gives the company a

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market value of six hundred million dollars That means that

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if someone wanted to buy the entire pie they could

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in theory pay six hundred million bucks assuming everyone would

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Sell them all their shares for fifteen bucks each and

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the shares outstanding Change Sure Bunch of factors change that

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number all the time When an employee decides to either

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buy out or sell the stock options granted to her

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when she joined the company Well those options convert into

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shares So if she had ten thousand options and sold

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them the company would have then ten thousand fewer options

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outstanding We're kind of like a liability but it would

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now have forty million ten thousand shares outstanding The options

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just converted into shares on men Okay what if the

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company wanted to raise thirty million bucks to buy a

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small competitors for all cash Well it could sell to

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the public two million shares at fifteen bucks a pop

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Did it already own those shares Well likely not They

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weren't just sitting in the vault in treasury stock so

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it had to print those shares out of thin air

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to dot and then sell them to new buyers So

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add two million to the total and now the company

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has forty two million ten thousand shares outstanding It also

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has thirty million bucks more in cash on its balance

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Sheet by the way now there's a danger in the

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increase in shares outstanding It's called share creep and it's

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not this guy Rather it refers to the gradual increase

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in shares outstanding otherwise known as dilution because now instead

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of a six hundred million dollar valuation with forty million

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shares at fifteen bucks the company if it were to

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still have a six hundred million dollar valuation now it's

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more shares outstanding would see its stock price drop teo

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six hundred million divided by forty two million ten thousand

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and yeah that gets you fourteen dollars in twenty eight

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cents a share So in the process of the options

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being converted and the cash being raised by selling equity

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the company destroyed seventy two cents a share in value

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Now in real life the market probably goes up and

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makes account for all that What were omitting here is

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that the company raised thirty million bucks of cash in

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the process Cash that well we investors presume it will

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use wisely and not on you know kibble for the 00:03:14.07 --> [endTime] office terrier

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