What is a fully diluted cap table?

A capitalization table (cap table) is a critical tool outlining startup equity ownership. It details shares held by investors, founders, and employees, providing a snapshot of company ownership. 

A fully diluted cap table goes further, incorporating all potential future shares, including options, warrants, and convertible securities. This comprehensive view projects the equity structure if all potential shares were converted and exercised.

But why does a fully diluted cap table matter? How can it affect your stakeholders? We will cover them here.

What is dilution?

Equity dilution is when the issue of additional equity shares lowers the ownership stake of current shareholders. Corporate finance and equity management depend heavily on this phenomenon, especially for startups and growing businesses.

The basic mechanics of dilution is straightforward: the overall number of remaining shares rises as an organization issues new shares. That means that unless current shareholders purchase more shares to maintain their relative position, their proportionate ownership of the company decreases. This procedure impacts each share’s claim to earnings, voting power, and ownership proportion.

For example, if a company starts with 1,000,000 shares and then issues another 500,000, a shareholder who owned 100,000 shares, or 10% of the company, would now only own 6.67%, assuming they don’t buy any more shares.

Factors that contribute to dilution

Several factors contribute to dilution:

• When a company issues additional shares to raise capital,it increases the total number of outstanding shares ,resulting in diluting existing shareholders ownership percentages.
• Dilution can happen when instruments like convertible bonds or preferred stock that can be converted into common shares .
• At the time when employees exercise their stock options ,new shares are issued ,potentially diluting existing shareholders ownership.
• At the time of mergers and acquisitions new shares may be issued to acquire another company,resulting in dilution for existing shareholders.
• Option pool expansion can dilute existing shareholders depending on when it occurs relative to funding rounds.
• During funding rounds instruments like SAFE or convertible notes can lead to dilution.
• Type of valuation used in a funding round can also affect the dilution.

Anti-Dilution Provisions

Certain options and convertible stocks have clauses known as anti-dilution provisions, which help protect investors against their investments possibly losing value. These provisions are also known as preemptive rights, subscription privileges, anti-dilution clauses, and subscription rights.

Let’s explore an example to understand the two kinds of anti-dilution provisions.

Consider a company Tech Innovate, a software company, offering cloud storage and data security solutions for businesses.

The company launched a fundraising campaign to expand operations, develop new products, and grow its market presence. It took an investment of $1 millionin the form of fundingfrom Investor A. With this investment, the share price buy-in was $5.00 per share.

Investment Amount	$1,000,000
Price Per Share	$5.00
Number of Shares	200,000

In the next financing round, it decided to issue new shares at $2.50 per share to Investor B (down round).

Full Ratchet

Under Full Ratchet, Investor A’s shares are adjusted to the new lowest price.

BEFORE ADJUSTMENT		AFTER ADJUSTMENT
Price Per Share	$5.00	Price Per Share	$2.50
Number of Shares	200,000	Number of Shares	400,000

Investor A now holds 400,000 shares, doubling their ownership percentage, and diluting other shareholders accordingly.

Weighted Average

The weighted average method calculates a new conversion price based on the average of the old and new issue prices.

The company took an investment of $1 million in the form of funding from Investor A. With this investment, the share price buy-in was $5.00 per share. In the next financing round, it decided to issue 100,000 shares at $2.50 per share to Investor B (down round).

INVESTOR A		INVESTOR B
Price Per Share	$5.00	Price Per Share	$2.50
Shares Issued	200,000	Shares Issued	100,000

CP2 = CP1 * (A+B) / (A+C)

• CP2 = New Conversion Price
• CP1 = Old Conversion Price
• A = Number of Shares outstanding before new issue
• B= Aggregate investment in new round of financing divided by CP1
• C= Number of shares issued in the new round

Substituting the values, we get

New Conversion Price = $5 * (1,000,000 +(250,000/5))/(1,000,000 + 100,000)

= $5 *(1,050,000)/ 1,100,000 = $4.77

Investor A’s shares are adjusted to the new conversion price.

BEFORE ADJUSTMENT		AFTER ADJUSTMENT
Price Per Share	$5.00	Price Per Share	$4.77
Number of Shares	200,000	Number of Shares	209,644

Investor A’s shares are now converted as if they had purchased at $4.77 per share instead of $5. So, Investor A would receive 209,644 shares to reflect this adjustment.

These anti-dilution provisions ensure fair treatment and protection for investors when a company raises additional capital. Both mechanisms have varying impacts on the company’s equity structure and the dilution experienced by existing shareholders.

Impact of Fully Diluted Cap Table

A fully diluted cap table is an important tool used by various stakeholders to understand the company’s equity structure and ownership distribution. It is crucial for all stakeholders to understand the ownership percentage and potential dilution. Let’s explore this through an example and understand how different stakeholders use it.

Consider a company Corp Pro, a growing company delivering innovative software products for businesses to enhance productivity and efficiency. 

Founders

The founders of the company are John Mark and Robert Shwan.  Their diverse expertise in engineering, business, and design is expected to drive the company’s growth in the industry. The total number of shares owned by the founders in the company is 1.5 million.

Founders use the cap table to:

• Anticipate future dilution impacts from funding rounds, employee stock options, and any convertible securities.
• Negotiating with investors to demonstrate the potential return on investment.

Founders use the fully diluted cap table as a tool for long-term planning. They can use it to model various situations and comprehend how future events can impact their control and ownership. The diluted cap table helps founders foresee these shifts and make well-informed decisions about when, how much, and under what conditions to seek capital.

Investors

Investors use the fully diluted cap table to consider potential “what-ifs” regarding future dilution possibilities. They figure out how things will turn out in the event of future equity awards, additional investment rounds, and convertible security conversions.

After developing its products, the company secured funding from investors to expand its market.

PRE- FUNDING		POST- FUNDING
Company Value	$6,000,000	Company Value	$7,145,000
Number of Shares	1,600,000	Number of Shares	1,900,000

The company took an investment in the form of “Seed” funding from investors. The total amount raised was $1.3 million to develop its product and expand its market. With this investment, the share price buy-in was $3.87 per share.

Investment Amount	$1,125,000
Price Per Share	$3.75
Number of Shares	300,000

The funding amount has been issued to shareholders as ”Preferred Shares” and categorized based on the funding round.

The investors analyze the cap table to:

• Assess the value of their investment and understand their ownership percentage post-investment.
• Understand how future funding rounds might dilute their ownership.

Employee Stock Options

The company plans to grant stock options to its employees as part of its compensation plan. Accordingly, the company has issued 60,000 stock options to its shareholders and has authorized 100,000 stock options to be granted in the future.

The employees use the cap table to:

• Make decisions about staying with the company, or joining the company if they are new hires.
• Understand the value of their stock options and their share of the company if they exercise their options.

Here’s the summarized fully diluted cap table of the company with the ownership percentage and capital committed.

The above fully diluted cap table, provides a transparent and detailed picture of ownership distribution, enabling decision-making and strategic planning for all stakeholders of the company.

Importance of a Fully Diluted Cap Table

A fully diluted cap table is essential during major business events like fundraising, mergers and acquisitions, and company exits. Here’s why it’s important:

Fundraising

During fundraising rounds, a fully diluted cap table shows potential investors the company’s equity structure after their investment. It demonstrates:

• The dilution effects of new equity being issued
• How investor shares may dilute in future rounds
• The company’s post-money valuation
• The price per share and amount of equity given for capital

With this information, investors can assess potential returns and negotiate investment terms.

Mergers and Acquisitions

In M&A scenarios, the fully diluted cap table helps to:

• Determine the company’s complete valuation/li>
• Account for all potential shares that could affect the total share count
• Negotiate share exchange ratios between companies
• Provide transparency on the equity exchanged
• Help assess the fair market value of the deal

Company Exits (IPO or Liquidation)

When preparing for an IPO or liquidation, a fully diluted cap table:

• Shows how proceeds will be distributed among shareholders
• Considers all securities that could convert into common stock (e.g., convertible bonds, warrants, preferred stocks)
• Helps determine the equity value per share for IPO pricing
• Ensures fair compensation for all stakeholders during liquidation

Efficiently manage your Cap table with Eqvista!

A fully diluted cap table provides a complete view of a company’s potential equity structure and helps stakeholders make informed decisions about investments, equity compensation, and overall company ownership.

A company should regularly update its fully diluted cap table to maintain accuracy and transparency. To minimize errors and ensure timely updates, many companies use Eqvista’s specialized cap table management software to automate much of the process and reduce the risk of manual errors. Get in touch with us now to learn more about our service.