Alex is Sprintlaw's co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
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If you’re raising capital, bringing on a co-founder, or offering equity incentives to attract talent, you’ve probably heard the term fully diluted shares.
It often comes up right when the stakes are highest: in investor term sheets, valuation discussions, and cap table modelling. And it can be a source of real confusion because it’s not always obvious which “shares” people are counting.
In plain terms, fully diluted shares is a way of answering a simple but crucial question:
“If every possible equity right turned into ordinary shares, how many shares would exist in total - and what percentage would each person actually own?”
Once you understand how fully diluted shares work, you’ll be able to negotiate investment terms more confidently, communicate clearly with investors, and avoid nasty surprises when options vest or notes convert.
What Are Fully Diluted Shares (And Why Do People Use Them)?
Fully diluted shares refers to the total number of shares that would be on issue if all relevant sources of potential equity were converted into ordinary shares, based on the assumptions used for a particular deal or cap table model.
Depending on how your documents define it, that can include:
- Shares currently issued (usually ordinary shares held by founders and existing shareholders)
- Options already granted under an employee share/option plan (whether vested or unvested)
- Other equity incentives or rights that could convert into shares
- Convertible instruments (like convertible notes or SAFEs) that could convert into equity
- Warrants or other rights to acquire shares (less common, but still relevant if they exist)
- In some deals, shares reserved for an option pool that hasn’t been allocated yet
People use fully diluted shares because it gives a more realistic picture of ownership after conversions/exercises that are expected (or assumed) to occur, rather than only looking at ownership today.
Issued Shares vs Fully Diluted Shares
A lot of misunderstanding happens when one party talks about “shares” but means issued shares, while another party is talking about fully diluted shares.
Issued shares = what’s already on issue today.
Fully diluted shares = what would be on issue after the specified conversions/exercises happen (or are assumed to happen).
If you’re a founder, you might focus on issued shares because that’s what you currently hold. But investors often focus on fully diluted shares because it reflects where the cap table is likely heading.
Is “Fully Diluted” Always Defined The Same Way?
Not necessarily. Different term sheets and investment documents define “fully diluted” differently.
For example, some definitions include:
- Only options that are already granted (not the entire pool)
- The entire option pool, whether or not options are granted yet
- Convertible notes only if they are expected to convert under the deal’s assumptions
- Convertible notes converting at a capped valuation vs at the next round price
This is why you should always ask: “What exactly is included in the fully diluted share count in this deal?”
Why Fully Diluted Shares Matter For Founders (And Investors)
Fully diluted shares matter because they drive the numbers that everyone cares about:
- Ownership percentage (who owns what, in reality)
- Price per share (how investors calculate what they’re paying)
- Valuation (pre-money and post-money often rely on a share count assumption)
- Dilution (how much your percentage drops over time as new equity is issued)
If you’re negotiating investment, the difference between counting issued shares and fully diluted shares can be material. You can think you’re giving away, say, 20% of the company, but if there’s an option pool and a converting note, the post-transaction ownership might look very different.
Founders: It Impacts Your “Real” Dilution
As a founder, the key is not just “How many shares do I own?” but:
“What % will I own after all existing and planned equity converts?”
This becomes especially important if:
- You’re creating an option pool before a funding round (common in startups)
- You’ve issued convertible notes for early funding
- You have multiple rounds planned and you want to model future dilution
Investors: It Helps Compare Deals Properly
Investors often want to compare opportunities on an “apples to apples” basis. A fully diluted share count can help by standardising the share count so the investor knows what they’re buying into, including existing obligations like options and convertibles (to the extent they’re included in the agreed definition).
It also reduces the risk of an investor thinking they’re getting a certain percentage of the company, only to discover later that a large option pool was assumed in the model and dilutes everyone.
How Do You Calculate Fully Diluted Shares?
There’s no single universal template, but the practical approach is straightforward: identify all equity that exists and all equity that could exist based on current rights, commitments, and the assumptions used in your deal documents.
Here’s a step-by-step process you can use as a founder when preparing for a raise (or when sanity-checking an investor’s calculations).
1. Start With Your Issued Share Capital
This is your current number of shares on issue (usually ordinary shares). You’ll typically find this in your company records and cap table.
If you’re unsure whether your paperwork matches what’s actually been issued, it’s worth checking that you’ve properly documented issuance (including Share certificates where appropriate) and shareholder approvals.
2. Add Existing Options And Equity Incentives
Next, add any options already granted (vested or unvested). Options are a common driver of dilution, especially if you’ve put in place an employee equity plan.
If you’re building or reviewing an employee option plan, it helps to understand the commercial and legal mechanics of Share options before you start promising equity percentages to key hires.
3. Add The Option Pool (If It’s Being “Counted”)
Many funding rounds assume an option pool exists (or will be created) and that it’s included in the fully diluted number. However, whether the unallocated portion of the pool is included depends on the agreed definition in the term sheet and transaction documents.
This can be a major negotiation point, because creating or topping up the pool before a round usually dilutes founders and existing shareholders first - not the incoming investor.
So when someone says “fully diluted shares,” you should check whether that includes:
- only granted options, or
- granted options + the unallocated pool
4. Add Convertible Notes, SAFEs, And Other Convertibles
Convertible instruments convert into shares based on rules in their documents, which might include:
- a valuation cap
- a conversion discount
- interest (for notes)
- a definition of the “next equity financing”
To calculate fully diluted shares including convertibles, you’ll usually model the conversion as if it happens at the next round price (or the capped price), depending on how the documents work and what assumptions you’re using for the calculation.
If there’s more than one possible conversion outcome (for example, cap vs discount), you may need a “best case / worst case” scenario model.
5. Check Any Special Rights To Acquire Shares
Less common for early-stage startups, but still worth checking:
- warrants
- rights issued under strategic partnerships
- milestone-based equity grants
Even if they’re not likely to be exercised, the key question is whether they are included in the definition of fully diluted shares for the purposes of your deal documents.
Fully Diluted Shares In Common Startup Scenarios
Fully diluted shares can feel abstract until you see where they come up in the real world. Below are some situations where you’ll commonly need to use a fully diluted share count - and what to watch for.
Scenario 1: You’re Creating An Employee Option Pool Before A Raise
It’s common for investors to ask you to create (or top up) an option pool as a condition of investment.
The key practical issue is who bears the dilution. Often the pool is created pre-investment so founders and existing holders are diluted, and the investor comes in “on top” of that.
That’s not always wrong - but it should be understood and negotiated clearly.
From a documentation perspective, you’ll also want your company’s rules to support the equity structure you’re building, which often means checking whether your Company constitution is suitable for issuing new shares and options in the way you intend.
Scenario 2: Different Share Classes Exist (Or Will Be Issued)
Not all “shares” are the same.
Depending on the deal, investors may receive preference shares with specific rights (for example, liquidation preferences, anti-dilution protections, or special voting rights). Even if the fully diluted share count expresses everything as a “number of shares,” the rights attached to those shares can matter just as much as the percentage.
If your company is (or will be) issuing different types of shares, it’s worth understanding Different classes of shares so you can see how economics and control can shift even when the share count looks clean.
Scenario 3: You’ve Issued Convertible Notes Early On
Convertible notes can be a fast way to raise funds, but they make fully diluted calculations more complex because you’re estimating future conversion into shares.
Two common points to clarify in negotiations are:
- What price are the notes assumed to convert at? (cap, discount, or round price)
- Is the conversion included in the “fully diluted” definition used to calculate investor ownership?
If you don’t model this early, you can end up surprised by how much equity is actually allocated to noteholders once conversion happens.
Scenario 4: Secondary Sales Or Founder Equity Transfers
If founders transfer shares (or sell some equity to new investors as a “secondary”), it doesn’t always change the fully diluted share count - but it changes who holds those shares, which affects voting control, future dilution dynamics, and alignment.
If you’re planning any equity movement between people (including co-founders leaving), you’ll want to handle the mechanics properly, including board and shareholder approvals and any restrictions in your documents. The process is often governed by your constitution and shareholder arrangements, and practically involves documents like How to transfer shares explains.
What Legal Documents Help Keep Fully Diluted Shares Clear (And Avoid Disputes)?
When fully diluted shares become a flashpoint, it’s usually not because the maths is impossible - it’s because the underlying rights weren’t documented clearly, or because different people are working off different assumptions.
As your company grows, keeping your equity structure clean is a legal and commercial best practice. Here are some of the key documents that typically matter.
Shareholders Agreement
A Shareholders Agreement helps set expectations between founders and other shareholders, including how decisions get made, what happens if someone wants to exit, and what approvals are required for issuing new shares.
This becomes especially important once dilution events occur (like option exercises or funding rounds), because it reduces the risk of disputes about control, valuation, and future fundraising rights.
Company Constitution
Your constitution is the internal rulebook for your company. It often sets out processes for issuing shares, transferring shares, and dealing with different share classes.
If your constitution doesn’t reflect what you’re trying to do (for example, you’re planning an option plan, or multiple share classes, or a large raise), it can slow down deals or create technical compliance issues.
Option Plan Documents (And Option Deeds)
If you’re granting equity incentives, you want clear documents that spell out:
- vesting rules
- exercise price and exercise mechanics
- what happens if someone leaves
- whether there are good leaver / bad leaver outcomes
This is typically done through a combination of plan rules and individual grant documents such as an Option deed.
These documents directly affect your fully diluted share count because they define what can convert into shares and on what terms.
Clear Share Issuance And Cap Table Records
Founders sometimes focus heavily on future dilution (options and notes), but basic share issuance hygiene matters too.
Keeping accurate records of issuances, transfers, and cancellations is essential for:
- due diligence in a funding round
- avoiding “phantom equity” disputes
- making sure your fully diluted shares figure is actually reliable
It also helps to align your legal records with what your investors and advisors expect to see.
Key Takeaways
- Fully diluted shares represents the total shares that would exist if options, convertibles, and other equity rights were converted into shares, based on the definition and assumptions used.
- Founders should use fully diluted modelling to understand their true dilution, especially when creating an option pool or raising capital through convertibles.
- Investors often price and negotiate deals using a fully diluted share count, so it’s important you’re aligned on what’s included in the definition.
- Fully diluted calculations can change depending on whether unallocated option pools and convertible notes are included - always clarify assumptions in the term sheet and deal documents.
- Strong documentation (like a Shareholders Agreement, constitution, and option documents) helps prevent disputes and keeps your cap table clean as you grow.
This article is general information only and isn’t legal, financial or tax advice. Equity arrangements (including options and convertibles) can have legal and tax consequences, so you should get advice tailored to your circumstances.
If you’d like help setting up or reviewing your equity structure, option pool, or investment documents, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
