Dilution is the reduction of a shareholder's ownership percentage that is caused by the issuance of additional shares. This is a primary concern when a business is evaluating whether to raise funds by selling stock. It is a particular concern in a closely-held organization, where the current shareholders control the business and do not want to lose control to new shareholders.
For example, a shareholder owns 1,000 shares of a company's stock, which is 10% of the 10,000 total shares outstanding. If the company issues an additional 5,000 shares, the shareholder's ownership percentage will have been diluted to 6.66%.
Dilution can also occur when convertible instruments (such as bonds) are converted into stock, when options and warrants are exercised, or when common shares are issued if specified conditions are satisfied.
Dilution will not occur if a business can use the funds raised by issuing shares to increase profits by a sufficient amount to offset the dilution.