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Updated August 29, 2023You’re reading an excerpt of Angel Investing: Start to Finish, a book by Joe Wallin and Pete Baltaxe. It is the most comprehensive practical and legal guide available, written to help investors and entrepreneurs avoid making expensive mistakes. 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.
In the dilution examples above, we determined ownership percentage and the number of shares to be sold to the investors without ever calculating the price per share. We did that by first calculating the percentage being bought by the investors using the pre-money valuation and the investment amount:
To calculate the number of shares, we had to decide which total share number we were going to use (issued and outstanding or fully diluted); and because we wanted as many shares as possible, we chose fully diluted. The formula for getting to the number of shares is:
If you are calculating the number of shares based on issued and outstanding shares only, you would substitute the issued and outstanding shares total for the fully diluted share total in the formula above.
Expressing the post investment ownership percentage in the term sheet is a valid way to ensure that there are no surprises. For example, the term sheet might say:
⚖️legaleseImmediately following the new investment, the purchasers of the Preferred Stock will own X% of the Company, calculated on a fully-diluted basis, including all issued and outstanding shares of stock on an as-converted to common stock basis, all convertible securities outstanding, and an available option pool of [10]%.
If you are going to make an offer to invest in a company through a term sheet, and you don’t know how many securities it has outstanding, and you want to assure yourself of your desired percentage after your money comes in, you will probably express the price per share on a post-money basis.
As we explain in Calculating Ownership and Dilution, there are two running share totals and it is possible to use either one in the calculation. The price per share in a fixed price round may be calculated by dividing the pre-money valuation by either the number of shares outstanding—the issued and outstanding shares—or the issued and outstanding shares on a fully diluted basis.
exampleLet’s look at the difference in the two approaches using our cap table from our scenario A example just above, where the Round 1 investors are buying 20% of the company for $250K at a $1M pre-money.
| Shares or Options | Issued and Outstanding | Fully Diluted | |
|---|---|---|---|
| Founders | 10,000,000 | 96.67% | 86.96% |
| Employees | 345,000 | 3.33% | 3.00% |
| Issued and Outstanding | 10,345,000 | 100.00% | |
| Option Pool | 1,155,000 | 10.04% | |
| Total Fully Diluted | 11,500,000 | 100.00% |