What are Fully Diluted Shares?
Fully diluted shares are all the shares a company has, including those to be issued due to obligations triggered by a liquidity or conversion event. The liquidity event is usually linked to a change of control of the company: if more than 51% of the share capital is acquired by another company, in case of a merger or or if it goes public.
Convertible loans or SAFE, ESOP, warrants and any obligation to be converted in equity are the main sources of fully diluted shares: they do not exist today, but they will if the company gets acquired or IPOes.
Investors who invest in startups usually invest taking into account the fully diluted pre-money valuation, that is, they are going to invest a certain amount in issuing new shares in exchange for a % of the company, already taking into account all prior obligations.
Examples of Fully Diluted Shares
Here is a step-by-step example of how fully diluted shares have an impact on a cap table.
The initial cap table is a common one in a company with founders that has received the first investment from business angels or FFF:
Issued shares equal fully diluted as there are no convertible obligations.
How does an ESOP impact the Cap Table?
Each equity plan impacts the cap table differently, depending on the type:
Stock options
In stock options plans, the participants are part of the cap table when they vest and exercise the options that the company has granted them. In addition to the visual part, it has an implication in the governance of the company since they also acquire political rights: right to vote, information, etc.
Example of a cap table where the board has approved an ESOP plan, and the company has already granted some shares that have already vested and been exercised. All ESOP shares are Common shares, whereas a company may have different share classes to give some additional rights to its stockholders.
Founder 3 was granted some shares that have already vested, which are added to the common ones he got when incorporating the company.
Virtual Stock Options
Participants in Phantom shares plans (also called Virtual Stock Options or RSU) will never be partners of the company, so simplifies the computation of the cap table. The phantom shares plan will appear in its entirety in the cap table, with 0 shares issued and the total shares of the plan in fully diluted.
For this tutorial, we have created a phantom share plan of 10% of the share capital, which at its creation ends up having 7.65% and dilutes the other shareholders. The VSOP accounts for 0 issued shares, but it is part of the fully diluted shares. For the first time since the company incorporation, the company has obligations to issue new shares upon a liquidity event.
It is important to note that only vested shares will be taken into account when calculating the fully diluted in case of sale. In other words, if we have an incentive plan with 320 shares and at the time of sale only 100 have been vested, the remaining 220 will never be issued* or taken into account in the calculations.
* For this example, we do not take into account possible vesting acceleration clauses that some plans have. The acceleration clauses allow the plan participants to consolidate the rest of the non-vested shares when a liquidity event happens (normally by 50% or 100%). There are several modes of acceleration, but we will not go into detail in this article.
Funding Round Dilution
It is very common for stock option or phantom share plans to be approved as part of a funding round. In these cases, the new investors invest in fully diluted pre-money, that is, they expect the ESOP to be approved before the capital injection. The result is that the pre-round shareholders will end up getting diluted when launching the plan, and also when closing the funding round.
Continuing with the example, the same company completes a funding round:
Fully Diluted Stock Calculators
Calculating fully diluted shares can be confusing and have calculation errors in Excel. Capboard offers several free tools for calculating and managing fully diluted shares:
- Dilution calculator: ideal to simulation how many shares need to be issued to a new shareholder to own X% of the company.
- Cap table generator: The easiest way to calculate an initial cap table and import it into Capboard. Make scenario projections in a matter of minutes.
- Cap table templates: different examples of cap tables to use in Excel or digitally.
You can create your cap table with automated fully diluted calculation on Capboard for free. It is simple and you will avoid calculation errors, in addition to being able to invite your shareholders.