What Happens When a Company Issues New Shares? | Is Diluting of Investors’ Holding a Bad Thing?

December 10, 2021 | Editorial Team

The company will increase the number of common stocks that investors trade in the stock market. Existing investors may start experiencing share dilution if the company issues too many shares, reducing their existing shares’ value. The company will struggle financially, leading to an increased stock selloff, causing the stock share price to fall (see also what happens when a company is taken over).

In some cases, it might be favourable for investors as they may benefit from higher dividend payouts, paying off the company’s debt, and returns on equity through capital gains. In this article, we dive deep to understand what happens when a company issues new shares traded in the stock market. On a separate note, see also what stocks are best to buy at Christmas.

Why Don’t Investors Like a Company Issuing New Shares?

Many investors and brokerages do not like the idea of a company issuing more shares because it means equity financing might water down the existing ownership. Some investors might even sell their stock altogether.

When a company issues new shares, it will have a lower net worth than before. It has less cash, fewer assets, and fewer employees. Investors who own the company’s old shares will see their holdings decrease.

Share Dilution

As mentioned earlier, when a company issues new shares, share dilution, impacting the existing shareholders. The existing shares will be less valuable as each will represent a smaller percentage of ownership. For instance, let us take an example of a company having 100 outstanding shares.

Suppose an investor owns 10% of the company’s stock, and the company issues 100 additional new shares, the investor’s new stock will be 5%. The company’s market capitalization is doubled by adding 200 outstanding shares, which dilute the investor’s holdings.

Impact on Stock Price

The company will find its stocks declining when the EPS decreases from new equity financing. However, it doesn’t mean the company’s executive management team has made a bad decision through new equity financing. The company might use the funds to eliminate or reduce the interest expense by paying down its debt.

The only effort for the company to remain financially solvent in the business is to sell additional shares. Despite the company going down in a spiral, it might be a good sign to make stock price rise again. However, the stock price rarely rises unless optimistic investors believe they can use funds from new issuance to invest increasing profits in the long run. If you have made any profit, you shouldn’t consider selling the stock to reap even bigger profits. The stock price of the company might rise again, especially if it is one of the companies whose stocks you should hold forever, though that’s unlikely to be the case here. The point is if you buy these stocks during their low moments that will ensure you get the biggest returns on your investment. This is the list of the best small-cap stocks in Canada (see also Penny Stock Canada).

Impact on Earnings-per-Share

When a company (see blue-chip stocks) issues additional shares via equity financing, the earnings-per-share (EPS) decreases. If the earnings-per-share are lower, it might impact the stock’s current market price. Analysts, company executives, and investors usually monitor any changes in the EPS as it is an important metric in forecasting the company’s expected profitability. Once you have found a trading strategy that is successful for you, sticking with it can be beneficial. On a related note, see how day traders persist through these frustrations and continue to trade every day.

Is it a Good Move When a Company Issues More Shares?

Despite the negative effect on the company’s financial health, there are times when companies issue new shares. When a company issues additional shares, it does not necessarily mean that investors should avoid it as it could be beneficial in the long term. It’s just that you need to be able to make a quick decision if your investment starts to drop in value, as we explained in the day trading post we shared. However, choosing what type of investment you take is not an easy decision, especially if you are new to the stock market. For that reason, getting a robo advisor could be a good idea.

Companies often need to raise capital to expand their portfolios as is the case with Canada Nickel Stocks as the company is advancing their projects. Companies might also need to pay back debt or raise money from outside sources such as banks, venture capitalists, and private equity firms. When a company raises capital through equity financing, it becomes easier to grow and finance its businesses.

There will be ultimate gains in the stock price if the company invests the additional capital successfully. It will also compensate for the dilution of shares. Investors will realize more than sufficient dividends payouts even if there are no interest payments.

The company needs to keep track of the number of shares issued on the balance sheet. The funds raised by the company will be used to improve the balance sheet for general purposes. A strong balance sheet can withstand economic downturns and other unforeseen events in the company.

What Does it Mean When a Company Issues Shares?

A company may issue new shares to increase its value in the market and raise money to finance its business. For example, a company might issue new shares to other corporate bodies or investors in the stock market. In this case, the company must disclose the transaction details in its annual report.

A company generally issues its shares at the start of its life and more later on. Here are some of the reasons why a company might consider issuing shares:

  • To repay all or some of the company’s borrowing and debts.
  • When the company grants the employee or director share options.
  • When there is a need to repair a damaged balance sheet
  • When there is a need to fund the purchase of another company
  • To fund the company’s particular new developments or projects
  • The company might require new funds to grow and retain business ownership organically
  • Suppose stockholders do not want to receive a cash dividend. Instead, the company may assign their shares of the same value as the cash dividend.

What Does Issuing New Shares of Common Stock Do?

A company may issue common stock to increase its value in a particular market. The company may also use the proceeds to fund its operations, acquisitions, services, buy back stocks, or buy out a competitor. However, this will reduce the value of shares and proportional ownership of existing investors since the company adds more shareholders into the pool. 

The company will dilute the investors‘ optionable securities and secondary offerings to raise additional capital. The existing shareholders may sometimes view share dilution as negative because it reduces their voting power. Investors who own a large portion of shares can often take advantage of shareholders who own a lesser percentage of the company.

How Do Companies Issue Additional Shares?

A company can issue additional shares to other corporate bodies or investors in the public markets. This includes any security that has been authorized by the Securities and Exchange Commission (SEC). If the company wants to issue its shares to the public, it should follow certain guidelines and procedures.

Below is a step-by-step process a company should consider before issuing shares:

Provide the Applicants With a Form of Application: The company issues an application prospectus to those wishing to apply for shares. The applicant should submit the form to the company.

Shares Are Allotted Via Board Resolution: The company will file the allotment applications. A board of directors will convene to approve where the shares will be allotted.

Issue Share Certificates in Respect: The company will review the documents and decide whether they comply with the requirements. If it approves the document, the company can proceed with issuing the share certificates.

Delivering an SH01 Form to Companies House: SH01 document must reach the Companies House within the month of all shares. The form keeps accurate records of the shares divided and the shareholder structure.

Update the Register of Allotments & Members: Following the board approving the allotment. The company will update the register of members and allotments as primary evidence that the new shareholders have the correct documentation entered into the member’s register.

The Bottom Line

When companies issue shares to raise money for various purposes, it doesn’t mean that it might always be unfavourable for existing shareholders. However, the companies raise funds through stock market investments by allocating shares to new investors to fund the business operations than what was initially anticipated. As long as the company follows all the legal requirements, there shouldn’t be any problems with issuing shares.