Silicon Valley Legal Bible（2）How is the percentage of employee options calculated?

The Silicon Valley Legal Bible with Forty-Two Chapters, the legal dryness of entrepreneurship, a legal encyclopedia tailored for founders I am U.S. attorney Xiaoxiao Liu.

In the last issue, we introduced how to calculate the shares of founders of U.S. companies, including what are Authorized Shares, what are Issued and Outstanding Shares, and what are the more academic Legal Capital System and The audience asked me what else I had heard of. Some viewers asked me what I had heard about Fully Diluted Shares, and what is this about? This Fully Diluted Shares is actually the calculation of Option Pools, which are two different calculation systems from the Issued and Outstanding Shares of the founder.

Assuming a company with three founders and shares of 7,000,000, 2,000,000 and 1,000,000 respectively, the total Issued and Outstanding Shares would add up to 10,000,000, so if you ask the three founders Issued and Outstanding Basis (based on the number of outstanding shares) is 70%, 20% and 10%, which is very simple.

Later this company intends to set up Option Pools (Option Pools), to understand a problem first, we often hear of 20% Option Pools (Option Pools) what is the meaning? This 20% is in the end who is twenty percent, the denominator is how much?

Suppose there are only three founders now, Option Pools (Option Pools) have not been set up, to set up Option Pools (Option Pools) to do what is it? Some people say that the founders Issued and Outstanding Shares (Issued and Outstanding Shares) total 10,000,000, so is 20% 2,000,000, which should be close, but not.

Let's set the number of shares in Option Pools (option pools) to x, then we have the following equation:

x/(10,000,000+x)=20%

x=20%(10,000,000+x)

x=2,000,000+20%x
80%x=2,000,000
x=2,500,000

This gives the number of Option Pools (Option Pools), you will find what it means in fact, 20% of Option Pools (Option Pools) is Option Pools (Option Pools) occupy Issued and Outstanding Shares (issued and outstanding shares) and Option Pools (Option Pools) of the This is a bit like the relationship between solvent and solution in chemistry, you want to add alcohol to 1L of water to eventually account for 20%, then not add 200ml of alcohol, but add 250ml of alcohol, so that the final 250ml of alcohol in a solution of 1.25L of alcohol and water to just account for 20%, which is the so-called "solute + solvent = solution "

This is easier to understand.

Similarly, if we say we want to give an employee 1% of the options, then what is said? Some people will think it is only 1% of this (option pool), then it is too small, the employee will only think that you are fooling him. In fact, the denominator should be the "solution" in the "solute + solvent = solution" we just mentioned.

So if the founder says to give an employee 1% of the options, then it is

12,500,000*1%=125,000, that's still a lot, right?

Next comes the core question, which number is Fully Diluted Shares? It is actually the number of the solution, 12,500,000, which means that Fully Diluted Shares is actually the result of assuming that all options mature and are exercised into shares.

So with that said some founders will ask, if there are some options that are not fully matured, what about the part where Fully Diluted Shares are not enough? Actually, what? Don't take the number of Fully Diluted Shares too seriously, because this is a hypothetical situation. As you can imagine, most employees will not make it to 4 years after the options are issued, and even if they make it to 4 years, they may not exercise their options, and many options will go back to the Option Pools and be recycled. This idealized Fully Diluted Shares (fully diluted shares) is basically impossible to wait for the moment when all the options mature into shares. We can consider Fully Diluted Shares to be a "for information only" concept.

Also note here that for simplicity, we are only counting Issued and Outstanding Shares and Option Pools as Fully Diluted Shares, while in fact Simple Agreements for Future Equity, Convertible Note, and Warrant are all included in Fully Diluted Shares.

In addition, you should have noticed that the Fully Diluted Shares are already the "solution" part of the "solute + solvent = solution", which is already the largest number, in our example In our example, it is 12,500,000, but this number is still far below the 20,000,000 Authorized Shares, so how to understand this relationship? Following the example of "solute + solvent = solution", Authorized Shares can be thought of as a beaker of solution, as long as the solution does not exceed the beaker and does not overflow. No matter how much solution is in it, the total amount of solution is used as the 100% denominator.

The Silicon Valley Legal Bible with Forty-Two Chapters, the legal dryness of entrepreneurship. I am U.S. attorney Xiaoxiao Liu, and I will see you in the next issue.