“Fully diluted shares” refers to the number of shares of a company’s stock that would exist if all the company’s outstanding convertible securities were exercised for, or converted into, the company’s basic form of stock. A typical Delaware corporation’s basic form of stock is common stock. Convertible securities may include convertible promissory notes, SAFEs, preferred stock, stock options, and warrants.
The definition of fully diluted shares can vary depending on the context.
During fundraising, startups and their investors will use fully diluted shares as the denominator in price calculations. The price per share that investors will pay for a company’s preferred stock in a priced equity financing is calculated as:
Price Per Share = Valuation / Fully Diluted Shares
In this context, the definition of fully diluted shares is the sum, without double counting, of:
- The number of the company’s issued and outstanding shares of capital stock, counted as if such shares had been converted into common stock;
- Shares that would be issued and outstanding if all the company’s outstanding stock options, warrants, and other convertible securities were exercised for, or converted into, common stock; and
- All shares of common stock that are reserved but unissued under the company’s option pool.
Company Sale or Liquidation
In the context of a sale or liquidation of a company, the definition of fully diluted shares used for calculating the allocation of deal proceeds would not include the common stock reserved but unissued under the company’s option pool (item 3 above) because no one has a claim to those shares.