Fully-diluted capitalization is one of those terms that gets used quite a bit in the startup and venture capital communities. But what does it mean?
The easiest way is to think of fully-diluted capitalization is as the number of shares that have been issued. A company’s fully-diluted capitalization typically includes:
- outstanding common stock;
- outstanding preferred stock (calculated on an as converted to common stock basis)
- outstanding options;
- outstanding warrants (on an as exercised and as converted to common basis);
- restricted shares; and
- options reserved for future grant (aka, the “option pool”);
The fully-diluted capitalization number can be helpful when a startup is in discussions with potential investors, providing them with an idea of how much of the company their investment will buy. It is also used when determining the share price of an equity investment.
The size of the option pool is a big negotiation point as it is really a valuation issue. The earlier stage the company is and the more equity that is expected to be issued to future employees, the larger the investors will demand the pool to be. This way, the investors aren’t diluted by future issuances to employees and others.