Investments/ business law
What is "fully diluted" and why is it important?
How many shares should you get for your investment? So you agree on the valuation of the company. And you agree on the investment you are willing to make. Now then, how many shares are you to get? I often see new investors making mistakes when it comes to calculating their price per share, leading to them over-paying. Here is a quick help as regards the concept "fully diluted" that you should be aware of.
Fully diluted basis
Price per share calculation
So – when you are buying shares you will want to know the share price (the “PPS”). The baseline being that you will take the pre-money value and divide it with the number of outstanding shares (the “NOSH”).
What does fully diluted mean
However – this might miss an important piece of data. What if the company also has a number of warrants, convertibles or other share-related securities issued that will give the holder a right to acquire shares in the future? Your shares will be less valuable in such a case because the assets and value of the company do not change while the number of shares that will each entitle a part of that company value has increased without you having seen them coming. Think of it as sitting with a glass of soda. And then it turns out someone it was not pure soda in the glass, because someone had poured water filling half of the glass – the soda has been diluted and tastes off.
It’s the same with shares. The value of a share should therefore also take into account the dilution that will happen if all outstanding securities that do not yet show up as shares, are also regarded as shares already now. Then you will have a more accurate (and lower) valuation of the shares you are about to buy – i.e. a lower PPS, and if you miss this you will find that you may have paid a higher share price that is later diluted without you being able to affect it.
Example calculation of PPS on a fully diluted basis
Example:
Pre-Money valuation: 10 MEUR
NOSH: 100 000
PPS: 10 000 000 / 100 000 = 100 EUR
Issues convertibles: 25 000
PPS on a fully diluted bases: 10 000 000 / (100 000 + 25 000) = 75 EUR
This means that, if you look at the share price at a fully diluted basis you should pay 25 % LESS per share that if you just look at the share price on the basis of outstanding shares only.
Conclusion of what and why "fully diluted" matters
Fully diluted = all shares and all other securities that can be converted into shares are accounted for when you determine the share price. This is important for you so that you do not over pay and get fewer shares than you should be entitled to based on the valuation of the company you agree on and the investment you are making.
Stockholm, 2024-01-24
Author: Katarina Strandberg
Fully diluted basis
Price per share calculation
So – when you are buying shares you will want to know the share price (the “PPS”). The baseline being that you will take the pre-money value and divide it with the number of outstanding shares (the “NOSH”).
What does fully diluted mean
However – this might miss an important piece of data. What if the company also has a number of warrants, convertibles or other share-related securities issued that will give the holder a right to acquire shares in the future? Your shares will be less valuable in such a case because the assets and value of the company do not change while the number of shares that will each entitle a part of that company value has increased without you having seen them coming. Think of it as sitting with a glass of soda. And then it turns out someone it was not pure soda in the glass, because someone had poured water filling half of the glass – the soda has been diluted and tastes off.
It’s the same with shares. The value of a share should therefore also take into account the dilution that will happen if all outstanding securities that do not yet show up as shares, are also regarded as shares already now. Then you will have a more accurate (and lower) valuation of the shares you are about to buy – i.e. a lower PPS, and if you miss this you will find that you may have paid a higher share price that is later diluted without you being able to affect it.
Example calculation of PPS on a fully diluted basis
Example:
Pre-Money valuation: 10 MEUR
NOSH: 100 000
PPS: 10 000 000 / 100 000 = 100 EUR
Issues convertibles: 25 000
PPS on a fully diluted bases: 10 000 000 / (100 000 + 25 000) = 75 EUR
This means that, if you look at the share price at a fully diluted basis you should pay 25 % LESS per share that if you just look at the share price on the basis of outstanding shares only.
Conclusion of what and why "fully diluted" matters
Fully diluted = all shares and all other securities that can be converted into shares are accounted for when you determine the share price. This is important for you so that you do not over pay and get fewer shares than you should be entitled to based on the valuation of the company you agree on and the investment you are making.
Stockholm, 2024-01-24
Author: Katarina Strandberg