The distinction between “issued and outstanding” shares of a corporation as compared to “fully diluted” shares is important when analyzing ownership percentages and the way proceeds would be distributed if the corporation were acquired by a third party. Ownership can be calculated in the following two different ways.
Issued and Outstanding Shares
When a corporation issues shares of stock, the person or entity that purchased the shares becomes a shareholder. The corporation then records that transaction in its stock ledger to reflect the current ownership of the company. In this context, the shares are referred to as issued and outstanding.
For example, if a corporation has issued 6 million shares to Founder A and 2 million shares to Founder B, then the ownership on an issued and outstanding basis is calculated based on the 8 million shares that are issued and outstanding as of that date. The table below depicts the capitalization of this corporation on an issued and outstanding basis:
|Name||Issued and Outstanding Shares||Percentage Issued and Outstanding|
Fully Diluted Shares
When a corporation grants someone the right to buy shares later, such as granting stock options to an employee, those shares are not yet considered issued and outstanding. The shares are not yet recorded on the corporation’s stock ledger, and a person does not become a shareholder by holding stock options. If the option is exercised, however, the shares would then become issued and outstanding and the person would officially become a shareholder.
Corporations often reserve shares under an equity incentive plan for future issuance to employees and other service providers in the form of stock options or other equity awards. Those reserved shares are often referred to as the “unallocated option pool” or the “pool.” The unallocated option pool is not considered issued and outstanding.
A corporation’s fully diluted capitalization is calculated assuming that:
- All convertible preferred stock, warrants, and options granted by the company are converted to common stock or exercised by the holder and become issued and outstanding shares of common stock.
- All shares reserved for future awards are granted as options or other equity awards and are exercised by the holder and become issued and outstanding shares of common stock.
For example, if the corporation described above grants a stock option for one million shares to a new employee and reserves one million shares for future issuance pursuant to stock options or other equity awards, then 8 million shares would still be issued and outstanding, but 10 million shares would be issued and outstanding on a fully diluted basis (including the one million shares reserved for issuance pursuant to the outstanding stock option and the one million remaining shares in the unallocated option pool). The following table depicts the capitalization of this corporation on a fully diluted basis and illustrates how this affects the percentage ownership:
|Name||Issued and Outstanding Shares||Percentage Issued and Outstanding||Fully Diluted Shares||Percentage Fully Diluted|
Ultimately, whether a company calculates ownership based on the issued and outstanding shares or on a fully diluted basis may depend on the context. The important point is for the parties involved to clearly express their expectations and use the same method of calculation.