Fully diluted shares are the basic shares plus every share that options, warrants, restricted stock and convertibles would add if they turned into stock. In-the-money options and warrants are counted with the treasury stock method, unvested RSUs usually in full, and an in-the-money convertible either as all its shares or, if it settles the principal in cash, only the shares for the spread. In our first example, 200 million basic shares become 207.1 million before the convertible and 219.6 million with it. Soreno, an AI voice interview practice app for consulting, investment banking and other finance candidates, runs a free enterprise value calculator with no sign-up. For one option tranche worked step by step, see our treasury stock method question.
Updated
Kellan Software and every number here are invented by Soreno for practice. Shares in millions, dollars per share unless shown in millions. The stock trades at $50.00. Our valuation conventions, stated once: today's price (or the offer price in a takeover) in the treasury stock method, unvested RSUs counted in full, performance shares at target, and no taxes or vesting conditions modeled. GAAP's diluted EPS works differently, as the FAQ explains.
From the latest 10-K and 10-Q notes.
Each tranche is its own little treasury stock method. Our question page walks one tranche slowly, so here we go straight through four.
Treasury stock method at $50.00, millions of shares
| Security | Count | Strike | In the money? | Bought back | Net new shares |
|---|---|---|---|---|---|
| Options, tranche 1 | 6 | $20.00 | Yes | 2.4 | 3.6 |
| Options, tranche 2 | 4 | $40.00 | Yes | 3.2 | 0.8 |
| Options, tranche 3 | 3 | $60.00 | No | 0 | 0 |
| Warrants | 2 | $45.00 | Yes | 1.8 | 0.2 |
1. Each tranche
Tranche 1: 6 × $20.00 = $120 million of proceeds buys back 2.4 at $50.00, so 3.6 net. Tranche 2 adds 0.8. Tranche 3's $60.00 strike is above the price, so it adds nothing. Warrants add 0.2.
One tranche, step by step2. Restricted stock
RSUs have no exercise price, so there is nothing to buy back: 1.5 million in full. Performance shares at target add 1 million. Both are conventions. Some bankers count only RSUs expected to vest.
3. Total before the convertible
200 + 4.6 + 1.5 + 1 = 207.1 million.
Kellan's $500 million convertible bond converts at $40.00 a share. The stock is $50.00, so it is in the money.
1. If-converted
$500 million ÷ $40.00 = 12.5 million. Count them, and take the bond out of debt. Diluted shares 219.6 million, equity value $10,980 million, enterprise value $10,980 million + $1,000 million − $300 million = $11,680 million.
2. Net share settlement
If Kellan must pay the principal in cash and settle only the excess in shares: conversion value 12.5 million × $50.00 = $625 million, less $500 million of principal = $125 million, which is 2.5 million at $50.00. Keep the $500 million in debt.
3. Same answer
Equity 209.6 million × $50.00 = $10,480 million, plus $1,000 million + $500 million of debt, less $300 million = $11,680 million. The two methods split the same value between shares and debt differently.
4. The trap
Counting all 12.5 million and leaving the bond in debt counts the $500 million twice: $12,180 million.
5. Read the terms
The indenture says whether the principal is paid in cash. For diluted EPS, US GAAP since ASU 2020-06 requires the if-converted method for convertibles, so the EPS share count and a valuation count can differ.
A buyer will spend $14,000 million for all of Kellan's equity, and the convertible holders will convert. What price per share can it offer? The catch: the share count depends on the price, because option tranches move in or out of the money and their buyback shrinks as the price rises.
1. The naive answer
$14,000 million ÷ today's 219.6 million = $63.75. At that price tranche 3 is in the money and every tranche buys back fewer shares, so the count rises and the cost becomes $14,113 million, over budget.
2. Solve it
Find the price where price × diluted shares at that price = $14,000 million. Trying prices (or Excel's Goal Seek) lands on $63.26, with 221.31 million fully diluted: options and warrants add 6.31 million at that price.
3. Check
$63.26 × 221.31 million = $14,000 million. The offer is 27% above today's $50.00.
4. Say it
In a deal, every in-the-money security is counted at the offer price, which is what its holders receive. That makes the count circular, and a strong answer says so. It also checks the deal terms, since awards that vest on a sale and a convertible's make-whole provision can add shares.
From FASB: ASU 2020-06 (convertibles and EPS), FASB: summary of Statement No. 128, Earnings per Share, FASB Statement No. 128, Earnings per Share, now in ASC 260 and IFRS Foundation: IAS 33 Earnings per Share.
In our experience this comes up inside an enterprise value or deal question. The interviewer listens for a full list and for no double counting.
Options by tranche, warrants, RSUs and performance shares, convertibles and convertible preferred.
A convertible is shares or debt, never both.
Today's price for a trading valuation, the offer price in a deal, and the average price for GAAP EPS.
The equity compensation and debt notes of the latest filings, rolled forward if anything changed.
The short answers are ours. The note says what a strong answer adds.
How do you calculate diluted shares with the treasury stock method?
Short answer. Assume in-the-money options are exercised and the proceeds buy back shares at the share price. Only the net new shares are added.
Our question page works one tranche. A strong answer then extends it to several. Practice it, see a model answer
What goes into a fully diluted share count?
Short answer. Basic shares, plus the net shares from in-the-money options and warrants, restricted stock and performance shares, and in-the-money convertibles.
Says where each number comes from in the filings.
Do you count out-of-the-money options?
Short answer. No. Exercising them would cost more than the shares are worth. In a deal, check them again at the offer price.
Uses tranche 3 from example 1 as the case that flips.
How do you count RSUs and performance shares?
Short answer. RSUs usually in full, since there is no exercise price. Performance shares at target or at the expected payout, and say which.
Names the convention as a convention.
How do you treat a convertible bond in the share count?
Short answer. If it is in the money, either count all its shares and remove it from debt, or, if the principal is paid in cash, count only the shares for the spread and keep the principal as debt.
Shows that both give the same enterprise value.
What is net share settlement?
Short answer. The company pays the bond's principal in cash and delivers shares only for the value above it, so far fewer shares are issued.
Works the spread shares on numbers.
Why can the EPS share count differ from the valuation count?
Short answer. GAAP uses the average price over the period and the if-converted method for convertibles. A valuation uses today's or the offer price and follows the settlement terms.
Says which number to use for which purpose.
What is the difference between enterprise value and equity value?
Short answer. Equity value is price times fully diluted shares. Enterprise value adds debt, preferred stock and noncontrolling interest and takes off cash.
Links the convertible choice to the debt line. Practice it, see a model answer
In a takeover, which share price do you use for the count?
Short answer. The offer price, which makes the count circular. Solve it with a few tries or Goal Seek.
Works example 3's logic.
Walk me through a comparable company analysis.
Short answer. For each peer, equity value from fully diluted shares, then enterprise value and the multiples, then apply them to the target.
Says that basic shares understate each peer's value. Practice it, see a model answer
How do you tell whether an acquisition is accretive or dilutive?
Short answer. Compare the buyer's EPS after the deal with before, using the new diluted share count if it pays in stock.
Uses diluted, not basic, shares for both. Practice it, see a model answer
A company records $10 of stock-based compensation. Walk me through the three statements.
Short answer. Expense $10, net income down after tax, $10 added back in cash flow, paid-in capital up.
Connects the grants to the RSUs and options in the share count. Practice it, see a model answer
Kellan's 200 million basic shares leave out 19.6 million.
Run the treasury stock method tranche by tranche. Averaging strikes can count an out-of-the-money tranche.
All its shares plus the bond in debt overstates enterprise value by $500 million in example 2.
Use the offer price, and recheck which tranches are in the money at it.
The diluted EPS figure in a 10-K uses average prices and GAAP rules. Rebuild the count for a valuation.
Soreno's AI interviewer gives you a company's options, RSUs and a convertible, asks for the fully diluted count, then asks what changes at the offer price. You get a scored report on your answer.
Basic shares plus every share that options, warrants, restricted stock and convertibles would add if they turned into common stock. Bankers use them to get equity value from a share price.
Not quite. FASB's Statement No. 128 defines diluted EPS as reflecting the potential dilution if securities or contracts to issue common stock were exercised or converted. It is built for a period: under the treasury stock method as amended by ASU 2020-06, exercise is assumed at the beginning of the period and the proceeds buy stock at the average market price during the period. A valuation count is a point in time at today's or the offer price.
Since ASU 2020-06, by the if-converted method. FASB's summary of the update says the treasury stock method should no longer be used for convertible instruments, and that potential share settlement must be included when an instrument may be settled in cash or shares.
The IFRS Foundation's summary says IAS 33 requires basic and diluted EPS with equal prominence and defines dilution as the potential reduction in EPS from assuming convertibles are converted, options or warrants exercised, or shares issued when conditions are met.
Basic shares on the cover of the latest 10-K or 10-Q, options, RSUs and performance shares in the equity compensation note, and convertibles in the debt note. Roll them forward for anything issued since.
Not in a valuation share count, since holders wouldn't convert. Keep the bond in debt at face value.
