Diluted Shares: Understanding Your True Ownership

1-sentence takeaway: Diluted shares represent your potential ownership in a company after considering all possible sources of new shares, giving you a more realistic view than just looking at your current shares outstanding.

Think of a pitcher of lemonade. You pour yourself a glass (your current shares). Delicious! But what if someone adds water (more shares issued)? Your glass still has the same amount of lemonade, but it’s a smaller percentage of the whole pitcher. That smaller percentage is like your diluted share count.

What causes dilution?

Dilution happens when a company issues more shares, decreasing your proportional ownership. Common causes include:

• Stock option exercises: When employees or advisors exercise their stock options, new shares are created and added to the total outstanding.
• New funding rounds: When a company raises money, it often issues new shares to investors.
• Employee stock purchase plans (ESPPs): These plans allow employees to purchase company stock, often at a discount, which can also create new shares.
• Warrants: Similar to options, warrants give the holder the right to buy shares at a specific price. When exercised, they lead to the issuance of new shares.

Why are diluted shares important?

• Realistic ownership: Diluted shares provide a more accurate picture of your ownership stake than outstanding shares alone, which don’t account for future dilution. This is crucial for understanding the potential value of your equity.
• Decision-making: Knowing your diluted ownership helps you make informed decisions about selling shares. For example, a lower-than-expected diluted ownership percentage might make you reconsider selling a large chunk of your current holdings.
• Negotiations: During fundraising or other negotiations, understanding diluted ownership is essential for ensuring you receive a fair deal.

Diluted vs. Outstanding Shares:

• Outstanding shares: The total number of shares currently issued by a company and held by investors.
• Diluted shares: Outstanding shares plus the potential shares that could be issued from options, warrants, convertible notes, etc.

How to calculate diluted shares:

Calculating diluted shares can be complex. It involves considering various factors like the type of equity, vesting schedules, and conversion ratios. Often, the company itself will provide this information. If you’re unsure, consult your company’s legal or finance team, or a financial advisor.

Example:

Imagine a company has 1,000,000 outstanding shares. It also has granted stock options for 200,000 shares. In this simplified example, the fully diluted share count would be 1,200,000. Note: This is a simplified example. Actual calculations can be more complex.

Learn More: The Cap Table (Capitalization Table) Learn More: Stock Options Learn More: Understanding Your Stock Options (ISO vs. NSO)

So here’s what we covered:

• What diluted shares are and why they matter.
• Common causes of dilution.
• The difference between diluted and outstanding shares.
• How to calculate diluted shares (and where to get help if needed).
• Why understanding dilution is critical for making informed decisions about your equity.