Dilution (also known as stock or equity dilution) occurs when a company issues new stock which results in a decrease of an existing stockholder's ownership percentage of that company.
Market cap—or market capitalization—refers to the total value of all a company's shares of stock. It is calculated by multiplying the price of a stock by its total number of outstanding shares. For example, a company with 20 million shares selling at $50 a share would have a market cap of $1 billion.
The treasury stock method is an approach companies use to compute the number of new shares that may potentially be created by unexercised in-the-money warrants and options, where the exercise price is less than the current share price.
Market Cap FormulaShares Outstanding = the total shares of common stock issued (excluding those held as treasury stock)
You can calculate enterprise value by adding a corporation's market capitalization, preferred stock, and outstanding debt together and then subtracting out the cash and cash equivalents found on the balance sheet.
Fully diluted refers to all the shares of a company in issue, plus all shares which are the subject of options, warrants, or other contractual rights to be issued in the future.
Maturity Date: Convertible notes carry a maturity date, at which the notes are due and payable to the investors if they have not already converted to equity. The most common method of conversion occurs when a subsequent equity investment exceeds a certain threshold. This is called a qualified financing.
Usually, the pre-money valuation is agreed on a “fully diluted basis”, which means that the value per share is determined considering not only any existing shares but also all shares that are promised or granted to employees, consultants, business partners and financial institutions, e.g. under an employee stock option
Because of the dilution that warrants represent, the value of that call needs to be divided by (1 + q) where q is the ratio of warrants to outstanding shares, assuming each warrant is worth one share. The formula gives the theoretical value of an option.
A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round; in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.
How to determine your valuation cap
- the amount you're raising on the convertible note (say $500k),
- the conversion discount of the note (say 20%),
- the pre-money valuation cap of the note (say $4m),
- the percentage of your company which the VCs will take in your Series A (say 30%),
Like common shares, the value of convertible preference shares depends on both the value of the company itself and the rights attached to the shares. In valuing these, one needs to estimate the company value, and then allocate it to different classes of shares based on their respective terms.
The Valuation Cap is the most important term of a convertible note or a SAFE. It entitles investors to equity priced at the lower of the valuation cap or the pre-money valuation in the subsequent financing. The valuation cap sets the maximum price that your convertible security will convert into equity.
A pre-money valuation refers to the value of a company before it goes public or receives other investments such as external funding or financing. The term, which is also simply referred to as pre-money, is often used by venture capitalists and other investors who aren't immediately involved in a company.
Shares that are fully diluted are the ones that are outstanding when all securities that can be converted (convertible bonds and stock options) are converted into common stock. Another example of diluted versus undiluted shares is corporation XYZ with 100,000 outstanding shares that are valued at $10 per share.
Basic shares represent the number of common shares that are outstanding today (or as of the reporting date). Fully diluted shares equals basic shares plus the potentially dilutive effect from any outstanding stock options, warrants, convertible preferred stock or convertible debt.
Exercising stock options means purchasing shares of the issuer's common stock at the set price defined in your option grant. If you decide to purchase shares, you own a piece of the company.
Outstanding stock options refer to unexercised and non-expired rights to purchase or sell the shares of a company. They can be short-term or medium-term investments. If you are an investor, it is important to know how much each outstanding stock option contract costs and when it can be exercised.
Exercising stock options is dilutive to shareholders when it results in an increase in the number of shares outstanding. Dilution decreases each shareholder's stake in the company but is often necessary when a company requires new capital for operations.
An option pool refers to a block of company equity that has been reserved for early investors or employees of a start-up company. The option pool is used to attract capital or talent when a company is growing and not yet producing enough revenue or cash flows to be viable without that investment or employment.
Outstanding shares are the company's stock that have been authorized and issued, representing ownership of the company by investors or institutions holding those shares. Fully diluted shares include all those equities plus additional shares if all convertible securities of a company were exercised.
In the vast majority of cases, options are granted “at the money, ”which means that the exercise price matches the stock price at the time of the grant. A small minority of options are granted “out of the money,” with an exercise price higher than the stock price—these are premium options.
Employee stock options (ESOs) are a type of equity compensation granted by companies to their employees and executives. These options come in the form of regular call options and give the employee the right to buy the company's stock at a specified price for a finite period of time.
