By Bryan Keythman. Market Cap Vs. Fully Diluted Market Capitalization. Castillo and Peter J. Securities and Exchange Commission: Company Search. This calculation uses the treasury stock method to calculate diluted shares, the same method generally accepted accounting principles, or GAAP, require a company to use. Purchase the book to support the authors and the ad-free Holloway reading experience. You get instant digital access, commentary and future updates, and a high-quality PDF download.
Allocating stock options for an employee stock option plan (ESOP)
As we saw in the pricing discussion above, the difference between a calculation based on issued and outstanding shares versus fully diluted shares can be significant. The option pool is typically the biggest component of the difference between issued and outstanding and fully diluted shares, and so the size of that option pool tends to get a lot of scrutiny at the time of any investment. As a company hires employees, it issues grants of options on the stock that is reserved for the stock option pool , thereby slowly depleting that pool.
It is common that a company has to top up its stock option pool several times as it grows from no employees to dozens, to hundreds, to potentially thousands. When the company adds more shares to the option pool, it dilutes all the existing stockholders when using the fully diluted ownership calculation.
It is a round of dilution without directly bringing in any money the way a stock sale to investors does.
Dilution and Stock Option Pools | IPOhub
Savvy investors know that the company should have a healthy stock option pool so it can motivate the new employees it wants to hire with the money it is raising. So as part of almost any priced investment round there is a discussion about how big the pool should be and who is going to take the dilution hit.
New investors want to allocate additional shares to the pool in a way that dilutes the existing equity holders before the new investors come in. The company would prefer if the option pool were topped up after the new money came in, as the dilution to the founders and prior investors would be less because the new investors would be sharing in that dilution.
How is equity typically diluted in share incentive plans?
If you look back to Figure A2, you will see that the stock option pool is down to 6. This question originally appeared on Quora - the place to gain and share knowledge, empowering people to learn from others and better understand the world.
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How Employee Stock Options Can Influence the Value of Ordinary Shares
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