With that in mind, dilution of shares doesn`t have to be a bad thing for investors. As mentioned earlier, stock dilution doesn`t happen for no reason (or at least it shouldn`t). If a company has a valid reason to issue new shares and/or uses the money raised to significantly improve its operations, then everyone can be happy. After all, it`s better to own 10% of a cake leaf the size of a football field than to own 20% of a cupcake. Share dilution can also occur when a company buys or acquires a new company. This can happen for a variety of reasons. For example, a company may decide to issue new shares to the shareholders of the company it acquires in return for the transaction. But not carefully managing equity dilution can result in less control over the business and less show for innovation and the entrepreneur`s hard work. To limit equity dilution, avoid these five most common mistakes when raising capital in your business. The minority shareholder may also be entitled to the conversion of shares, in particular if he has altered the condition of his shares by dilution by infringing the subscription rights. Even in the absence of subscription rights, dilution that effectively eliminates a minority shareholder would certainly meet the fifth circuit definition of the “dominance or control” element under Texas law, a corporate stock that reduces the value of the plaintiff`s shares. Such an application of the tort of share conversion to shareholder dilution would be an important extension of the law, and the affirmative bona fide defence would almost certainly apply. The courts have ruled almost unanimously that actions based on shareholder dilution are derivative shares and must be brought on behalf of the corporation and not by the individual shareholder.
The only notable exception was Gentile v. Rossette before the Delaware Supreme Court. The Delaware Court held that a minority shareholder has an individual cause of action for dilution of shareholders if: “(1) a shareholder with majority or effective control causes the Company to issue `excessive` shares of its shares in exchange for assets of the controlling shareholder that are of lesser value; and (2) the exchange has the effect of increasing the percentage of outstanding shares held by the majority shareholder and consequently reducing the proportion of shares held by public (minority) shareholders. In the case of non-Jews, the company had been stripped of its assets and dissolved, so there was no recourse for derivative claims because there was no corporation. In a subsequent unpublished notice from the Court of Chancery, the plaintiff was attributed the approximate difference in value between the pre- and post-dilution shares, a measure that the court did not consider “perfect,” particularly because of the weakness of the evidence in court, but the court ruled that the award was fair and that the defendant could not be heard. complain about incomplete financial records for which he was responsible. Texas is unlikely to follow the non-Jewish exception under a fiduciary theory of duty. Delaware courts are far more willing to extend directors` fiduciary duties directly to shareholders, if necessary, than what the Ritchie court has indicated is permitted by Texas law. The simple answer is no. Share dilution may seem negative to shareholders as it can reduce their equity and the percentage of shares held in the company. However, when a start-up begins a second investment cycle, it usually means that the business is able to expand and undertake new ventures.
The injection of cash from the newly issued shares and the subsequent growth of the Company are expected to increase the value of the shares of existing shareholders. The cash conversion method is also applied to convertible bonds. After-tax interest on convertible debt is added to the net income of the numerator and new common shares that would be issued upon conversion are added to the denominator. Alternatively, the shareholder could bring an action for damages through a derivative action. Section 21.162 deals only with the validity of issued shares, it does not override the fiduciary duties of directors when they enter into an unfair transaction with the Corporation. If the circumstances of the share issuance do not constitute “fraud” to invalidate the shares, the controlling shareholder (through control of or position on the board) would still have a fiduciary duty of fairness and loyalty to the corporation, which, according to the Ritchie Court, would require that his or her shares be “exclusively” for the benefit of the corporation. If the controlling shareholder had acted to dilute the shareholders in order to benefit him, he would certainly have breached his fiduciary duties to the company. The action would consist of damages against the majority shareholder requiring him to pay the corporation the fair value of the shares issued to him, the difference between what he should have paid and what he paid.
Under the special rules applicable to derivative shares in shareholding companies, the minority shareholder could receive his proportionate share of damages directly. Dilution of shares can significantly alter the company`s short- and long-term performance. The positive or negative consequences of dilution depend largely on how the market perceives the reasons why the company raises capital. Initially, ownership of the company`s shares is divided among investors and the remaining shares are reserved for public trading.