Fully-Diluted Capitalization

Fully Diluted

A startup’s pre-money valuation, the determination of its worth prior to investments, is used to set the price of stock issued to investors. This process establishes the percentage of the corporation that a prospective investor will purchase for a given investment.

Capitalization — in this context — denotes the capital structure of the corporation. For capitalization to be considered diluted, the relative degree of ownership of the corporation (denoted by stock ownership) is reduced at each additional stock issuance. Taken a step further, the term fully-diluted implies that all obligations associated with the issuance of stock have been fulfilled.

As such, a startup’s fully-diluted capitalization generally implies:

  • preferred stock holdings have been converted to common stock;
  • outstanding options, warrants, and other securities with a right to acquire shares have been exercised; and
  • any shares reserved for issuance under a stock plan have been issued.

That said, there is no one overarching definition of fully-diluted capitalization. For example, shares that have been earmarked for issuance under a stock plan can be temporarily set aside from a fully-diluted capitalization.

This is common practice in the event that the calculation is being performed in preparation for an acquisition, as startups rarely issue equity post-acquisition.

Conversely, such shares are nearly always included in a fully-diluted capitalization in the context of equity compensation. Moreover, certain definitions call for the inclusion of convertible notes or safes, which will eventually convert into stock.