Issued and Outstanding Shares Versus Fully Diluted Shares

Understanding the distinction between issued and outstanding shares of a corporation as compared to fully diluted shares is critical when analyzing ownership percentages and the way proceeds would be distributed if the corporation were acquired. Ownership can be calculated in the following two different ways.

Issued and Outstanding Shares

When a corporation issues shares in exchange for payment, the person or entity that purchased the shares becomes a stockholder. The corporation then notes in its stock ledger that these shares are owned. The shares are referred to as issued and outstanding.

If a corporation has issued 3 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 5 million shares that are issued and outstanding. The following table depicts the capitalization of this corporation on an issued and outstanding basis:

Fully Diluted Shares

When a corporation grants someone the right to buy shares later, such as granting a stock option to an employee, those shares are not yet issued and outstanding. The shares do not appear on the corporation’s stock ledger, and a person does not become a stockholder by holding them. If the option is exercised, however, the shares would then become issued and outstanding and the person would become a stockholder.

Corporations typically 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:

1. All convertible preferred stock, warrants and options it has granted are actually converted to common stock or exercised by the holder and become issued and outstanding shares of common stock.
2. 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 250,000 shares to a new employee and reserves 750,000 shares for future issuance pursuant to stock options or other equity awards, then 5 million shares would still be issued and outstanding, but 6 million shares would be issued and outstanding on a fully diluted basis (including the 250,000 shares reserved for issuance pursuant to the outstanding stock option and the 750,000 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:

Ultimately, whether a company calculates ownership based on the issued and outstanding shares or on a fully diluted basis may depend on the context for the calculation. Most importantly, however, the parties involved should clearly express their expectations and use the same method of calculation.