Understanding Outstanding Shares and Fully Diluted Shares: A Fundamental Guide for Analysts and Investors

When evaluating a company's equity structure or calculating metrics such as market capitalization, analysts often consider the fully diluted shares outstanding, which includes all potential shares that could be issued from options, warrants, and convertible securities. This provides a more comprehensive view of the company's equity and potential dilution from the employee option pool.

Outstanding Shares vs. Fully Diluted Shares

Outstanding shares do not include unexercised employee stock options. These options represent potential shares that have not yet been issued, and as such, are not included in the basic share count. However, when considering a company's equity structure or market valuation, it is crucial to take into account the fullest possible share scenario, which is why fully diluted shares are important.

For public companies, the concept of outstanding shares is different from the diluted share count. The diluted share count is the actual number of shares that would be outstanding if all potential shares from options, warrants, and convertible securities were exercised. The company's provided diluted share count may not be precise due to the adjustments made by accountants, but this difference is often minimal and does not significantly impact the valuation. However, for small or nano-cap companies, these discrepancies can lead to significant differences in valuation. Therefore, it is essential to perform thorough due diligence to uncover any hidden share counts.

Contextual Implications and Due Diligence

When it comes to private companies, understanding the concept of outstanding shares and fully diluted shares is equally important. The authorized share limit, defined in the company's Certificate of Incorporation, acts as the maximum number of shares. This limit can be adjusted through Board or shareholder resolutions to designate specific numbers of shares for options, conversions, and other uses. This means that the company's actual equity structure can vary significantly based on these adjustments.

For private companies, legal language can sometimes add complexity. For example, the term 'not treasury trees' might be used to describe shares that have not been issued and therefore do not exist in the company's treasury. This can be confusing, but it simply means that the authorized shares have not yet been allotted or sold. The authorized shares are like the plot of land a company is allowed to develop. However, only a certain portion of these authorized shares might be issuable through various mechanisms such as option plans, conversion, and preferred shares.

Conclusion

Understanding the distinction between outstanding shares and fully diluted shares is crucial for accurate financial analysis and valuation. While the impact of these differences may be minimal in large, well-known public companies, it can significantly affect the valuation of smaller companies. Therefore, for a comprehensive and accurate financial analysis, always consider the fully diluted share count to get a complete picture of a company's equity structure.

For more on this topic, you might want to explore outstanding shares, diluted shares, and market capitalization.