Dilution is the extent to which shareholder value erodes due to transfer of value created by their share holdings to new shareholders. This situation usually occurs when new shares are issued or when holders of stock options, such as company employees, or holders of similar securities (convertibles and warrants) exercise their rights. With the number of shares outstanding increasing, each existing stockholder ends up owning a smaller percentage of the pie (equity or total shares outstanding), making each share holdings lower in value.

The dilution factor represents the percentage of new shares issued (new capital raised) by an entity to the total shares after the new issue, with the overall value of these shares reflecting the new reality after issuance. In equation form:

Dilution factor = N/ (N + SP)

Where:

S = number of shares issued before the new round of share issuance

P = price per share of the new round of share issuance

N = amount of new shares issued/ new capital raised in the new round

Percentage dilution = dilution factor * 100

As a result of dilution, each existing shareholder (prior to new round of issuance) owns a lower percentage of the entity as reflected by the dilution factor (assuming these shareholders did not take part in the new round).