Watch the scene from the movie ‘The Social Network’ which talks about share dilution.
Case breakdown: Movie The Social Network:This scene shows how the co-founder of Facebook, Eduardo Saverin (played by Andrew Garfield) was thrown out of the company after his shareholding company was diluted. The scene shows how the co-founder of Facebook (Eduardo Saverin) is narrating the incident to his lawyer.
He was ambushed when he walked into the office of Facebook by Mark Zuckerberg, when $24 million fresh shares were issued, his ownership was diluted down to .03%. This made him extremely furious and he warns Mark Zuckerberg that he will come back for the entire shareholding. EduardoSaverin’s shareholding was diluted while the other 4 investors’ shareholding remained intact. Mark Zuckerberg’ (Played by Jesse Eisenberg), Sean Parker (played by Justin Timberlake), Dustin Maskovitz, and Peter Teal’s ownership or stake remained exactly the same in the company, While Eduardo’s shareholding came down to .03% from approximately 34.4%.
Dilution of Shares
Let’s understand what dilution means, Dilution according to the dictionary means “the action of making something weaker in force, content or value”. Think of a hard drink, adding water or any soft drink lessens the effect of that drink and sometimes changes its flavor.
Similarly, when shares are diluted, the shareholder loses his stake in the company. For example: Let’s say you invested in a small company (having a share capital of Rs. 50,000 divided into 50,000 shares of Rs.1 each), you currently have 5,000 shares, giving you a 10% stake in the company (5,000/50,000= 10). A new investor comes in and says they want to invest Rs.10,000 more. Share capital would then become Rs. 60,000 (50,000+10,000) and your share gets diluted to 8.33% (5,000/60,000).
Share dilution can take place in a number of ways. This can be done by companies issuing convertible bonds, warrants, or preference shares into the stock or employees can exercise their stock options.
Many companies have contracts that contain anti-dilution clauses to protect the founders and co-founders of the company. One of the earlier scenes from this movie reveals that Eduardo had signed an agreement that had a clause (which he wasn’t aware of) that he would have to sacrifice his shareholding in case, new investors enter the firm.