If your company is issuing shares, it is important to understand the impact of your decisions on existing and future shareholders. Shareholders may invest in your business with the expectation of having a certain amount of influence and ownership. However, your company may issue more shares or converts securities (equity or debt) into shares, causing dilution. Fully diluted shares are the total number of shares a company can issue if all appropriate securities are converted into shares. 

It is important to understand how many shares are on issue and what securities can be converted into shares in the future. This will help you to understand how your shareholders might be impacted when those securities are converted. This article explains:

  • the difference between fully diluted shares and undiluted shares;
  • what is included in the company’s fully diluted share capital; and 
  • when and why it is important to consider a company’s fully diluted share capital.

‘Undiluted’ vs. ‘Fully Diluted’

When most companies think about their share capital, they are thinking about their ‘undiluted’ share capital. This is the number of shares which currently exist and are actually on issue.  This is the total number of shares recorded by the Australian Securities and Investments Commission (ASIC).

By contrast, a company’s ‘fully diluted’ share capital refers to its current shares on issue, plus shares that could be issued in the future if the company’s options and other securities are converted into shares. For example, if your company currently has 1,000 shares on issue, then its undiluted share capital is 1,000 shares. If your company has an options pool that allows it to issue another 100 shares to employees, then your fully diluted share capital is 1,100 (i.e. your 1,000 current shares plus the 100 shares you may be required to issue in the future).

What Would Be Included in a Company’s Fully Diluted Share Capital?

A company’s fully diluted share capital includes securities that are converted into shares and issued, or approved to be issued in the future. For example, this commonly includes:

  • allocated options which the company has already issued to particular employees;
  • unallocated options which the company can issue to employees in the future (i.e. the company’s approved ‘option pool’);
  • convertible notes which the company has issued to investors; and
  •  ‘Simple Agreement for Future Equity‘ (SAFEs) which the company has issued to investors.

Why Fully Diluted Share Capital is Important

It is important to understand your company’s fully diluted share capital. This is because it indicates to shareholders how their shareholding might dilute in the future. For example, if the company has reserved a 20% options pool, then its shareholders know that the company is able to dilute their shareholding in the future by issuing additional shares totalling up to 20% of the company.

It is common for companies to prepare a ‘cap table’ which includes all of the company’s shares, options and other securities which may convert into shares. This allows shareholders to understand what percentage of the company they:

  • own now; and
  • might own in the future.

When Do I Need to Think About Fully Diluted Shares?

As a business owner, knowing your fully diluted share capital will help you to:

  • plan for the company’s future share structure; and
  • understand how issuing additional shares or securities will impact existing shareholders. 

It also helps shareholders and security holders to understand the percentage of the company they will own and how this might change in the future.

For example, if you intend to issue shares to investors, your investors will want to understand the company’s fully diluted share capital before they invest so they can understand what they are getting for their money. Your investor will want to know:

  •  the number of shares currently on issue;
  •  whether the company has reserved an options pool; and 
  • if it has any SAFEs or convertible notes that will convert as a result of their investment. 

These factors will all affect how their shareholding percentage might change over time.

Below is an example of a cap table that can be provided to investors. It helps them to understand the difference between their shareholding as a percentage of the company’s undiluted share capital versus as a percentage of its fully diluted share capital. In this example, the company’s issued shares are all owned by its founder. The company has approved an option pool of 15,000 options/shares to be issued in the future. The company is about to issue shares to a seed investor, which will also result in a SAFE converting.

 

Number of shares

% of undiluted

% of fully diluted

Founder

100,000

84.75%

75.19%

Seed Investor

10,000

8.47%%

7.52%

Option pool

15,000

 

11.28%

SAFE

8,000

6.78%

6.01%

Total no. of shares after seed investment (undiluted)

118,000

100%

 

Total no. of shares after seed investment  (fully diluted)

133,000

 

100%

Key Takeaways

Fully diluted shares are the total number of shares a company can issue if all appropriate securities are converted into shares. Understanding your fully diluted share capital will help the company to understand how its plans will impact current shareholders. Existing shareholders and potential investors will also understand how their shareholding might be diluted in the future, and how the percentage of the company that they own might change. 

If you are about to issue shares, options or other securities and would like to discuss your share structure, you can contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

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Sophie Mao
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