What Does Fully-Diluted Basis Mean?

First, you need to understand that there are several statuses that a share of stock (or any type of equity) can exist in. These statuses are:

- Issued

- Outstanding

- Reserved

- Authorized

Authorized stock is all the shares that the company is legally allowed to issue. This can be any number of shares, but companies typically authorize 10 million shares to start because it’s a standard practice that founders, early employees, and investors are comfortable with. Authorized stock is critical because you cannot legally issue more stock than is authorized, so anytime you are issuing stock you need to check that you actually have the stock to issue otherwise the issuance will be invalid. Similar to how if you own a grocery store, you can’t sell more bananas than you actually have available to sell.

Reserved stock is a portion of the authorized stock that a company reserves for specific purposes such as an employee stock pool or issuance of shares upon conversion of securities (e.g. Common Stock reserved for if/when Preferred Stock converts). Reserving stock for specific purposes helps you avoid inadvertently issuing or promising to issue more stock than you have authorized.

Issued stock is a portion of the authorized stock that the company has distributed to stakeholders (e.g. founders, employees, investors, etc).

Outstanding stock is similar to issued shares, but only refers to those issued shares that are still held by outside stakeholders and haven’t been repurchased by the company.

The status of a share comes into play because how the status you count will dramatically affect voting power and economic ownership.

Fully-diluted then is a broad and comprehensive way of counting shares because it refers to the total number of shares that are Issued, Outstanding, and Reserved. It only excludes shares that are Authorized but not Issued, Outstanding or Reserved.

You often hear investors and lawyers ask about fully-diluted because it provides a conservative “what-if” understanding of a company ownership structure; as in, what if all the Reserved shares are issued, how will my ownership and voting control be affected in such a scenario. Fortunately for founders, though, because Reserved shares are not actually issued or outstanding they don’t typically get factored into calculations for payouts in the event of acquisitions. Investors and stockholders just want to know how such Reserved shares could theoretically impact them.