Fully Diluted Shares: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Fully diluted shares are the total number of outstanding shares there would be if all convertible securities were converted to common stock.3 min read
2. Why Are Fully Diluted Shares Important?
4. Frequently Asked Questions
Fully Diluted: What Is It?
Fully diluted shares are the total number of outstanding shares there would be if all convertible securities were converted to common stock. Fully diluted is one way of measuring how many shares a company has. It helps investors determine the value of the company. Common stock are the shares held by employees, managers, and shareholders who have voting rights in a company.
Fully diluted shares take many things into account. Preferred stock, for instance, is held by individuals who receive their dividends before everyone else. These people do not, however, have voting rights. However, if they have convertible preferred stock, they can turn it into common stock.
There are other convertible securities, as well. Stock options allow individuals to purchase common stock at a set price before a certain expiration date. Convertible bonds can also be turned into common stock. Any security that can be converted to common stock is considered when measuring a company's fully diluted shares.
Why Are Fully Diluted Shares Important?
Issued and outstanding shares are those which have been authorized and issued to a company's shareholders. If you only consider these shares, you won't understand the actual value of a company.
For instance, you could authorize 5 million shares to be issued. But, if only 3 million of them are issued, there are still 2 million not counted under the “issued and outstanding” umbrella. If convertible securities turn into common stock, this can change the number of issued and outstanding shares substantially.
Fully diluted shares are important because they give investors and markets a better idea of a company's actual value. Investors look at earnings per share (EPS) when determining this value.
By looking at EPS with fully diluted shares, investors understand what their investment would be actually worth if all securities are converted. The following example illustrates this issue:
If an investor looks at a company and calculates EPS without looking at fully diluted shares, he may think there are only 1 million shares. If the company has earned $8 million, this means the earnings per share come to $8. However, if 500,000 convertible securities suddenly become common stock, there are now 1.5 million shares, and the new EPS is only $5.33.
Frequently Asked Questions
- How do you calculate EPS with fully diluted shares?
Subtract preferred dividends from net income. Divide this by the fully diluted weighted shares. You can find the fully diluted weighted shares by adding the shares from the beginning and end of a period and then dividing by two.
- Why is basic EPS always higher than fully diluted EPS?
- Why do companies release fully diluted share information?
Even though it makes shares seem less in worth, companies release this information because investors typically only purchase stock if they know the actual risk they're up against.
Even when explained, fully diluted shares can be a difficult concept to grasp. If you're ready to start issuing stock or simply have questions, post your legal need in UpCounsel's marketplace. The attorneys on UpCounsel have an average of 14 years experience, and since 95 percent of lawyers are screened out, you'll only get professionals from the country's best law schools, including Harvard and Yale.