Dilution of Shares

Learn about Share Dilution with Facebook

Watch the scene from the movie ‘The Social Network’ which talks about share dilution.

 

Case breakdown: Movie The Social Network:

This scene shows how co-founder of facebook, Edurado Saverin (Played by Andrew Garfield) was thrown out of the company after his share holding in the company was diluted.

The scene shows that how the co-founder of facebook (Edurado 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. Edurado Saverin’s shareholding was diluted while 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 same in the company, While Edurado’s shareholding came down to .03% from approximately 34.4%.

What is Share Dilution?

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 affect 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 share capital of Rs. 50,000 divided into 50,000 shares of Rs.1 each) , you currently have 5,000 shares, giving you 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 clause to protect the founders and co-founders of the company. One of the earlier scene from this movie reveals that Edurado had signed an agreement that had a clause (which he wasn’t aware about) that he would have to sacrifice his shareholding in case, new investors enter the firm.

Written by: Ms. Gitika Chandra

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