Share Dilution and Fully Diluted Shares in New Zealand

If you are raising capital, issuing shares to a new co-founder, or setting up an employee share scheme, dilution can catch you out fast.

Founders often make three mistakes early: they focus only on how much cash is coming in, they look at current shareholdings instead of the fully diluted position, and they agree terms before checking how option pools, convertible instruments, or future share issues will affect control. That is where small percentage changes can turn into major surprises.

Share dilution is not automatically bad. In many cases, it is the normal price of growth. The real issue is whether you understand what is being diluted, when it happens, and how to document it properly. This guide answers the practical questions New Zealand business owners usually ask: what fully diluted shares actually mean, when dilution matters, how it affects voting and economics, and what steps to take before you sign a term sheet or issue new equity.

Overview

Share dilution happens when a company issues more shares, so existing shareholders own a smaller percentage of the business than they did before. Fully diluted shares are the total number of shares that would exist if all rights to acquire shares, such as options or convertible securities, were exercised or converted.

The key point is that founders should assess both the current cap table and the fully diluted cap table before making decisions about fundraising, incentives, or ownership negotiations.

• Check how many shares are on issue now, and who holds them.
• Identify any options, warrants, convertible notes, SAFEs, or similar rights that could become shares later.
• Work out how a new issue changes percentage ownership, voting power, and dividend rights.
• Review your company constitution, shareholders agreement, and board approvals before issuing shares.
• Confirm whether pre-emptive rights, director duties, or investor consents apply.
• Make sure Companies Office records and internal registers are updated correctly.

What Share Dilution 101 Means For New Zealand Businesses

For a New Zealand company, share dilution means existing owners keep the same number of shares, but those shares represent a smaller slice of the company after new equity is created.

That sounds simple, but founders often mix up two different questions. The first is ownership percentage. The second is value. A shareholder can own a smaller percentage after a capital raise but still be better off if the company is worth more and has enough funding to grow.

Say a company has 100 shares and two founders each hold 50. If the company issues 25 new shares to an investor, each founder still has 50 shares, but now there are 125 shares on issue. Each founder drops from 50 percent to 40 percent. That is dilution.

Fully diluted shares take the analysis one step further. They assume all securities that could convert into shares actually do convert. This gives a more realistic picture of what ownership might look like, especially for startups that are fundraising or using equity incentives.

What Counts Towards A Fully Diluted Share Number?

The exact answer depends on the company documents and deal terms, but the fully diluted total often includes more than ordinary shares already issued.

• Issued ordinary shares.
• Preference shares that convert into ordinary shares.
• Employee share options or management incentive options.
• Warrants or rights to subscribe for shares.
• Convertible notes.
• SAFEs or other convertible instruments, if the terms clearly provide for future conversion.
• Reserved option pool shares, depending on how the transaction documents define fully diluted capital.

This is where founders often get caught. A term sheet might talk about an investor receiving a percentage on a fully diluted basis, but the founder is mentally calculating ownership only on current shares on issue. Those are very different numbers.

Why Founders Need To Understand The Difference

The main risk is not dilution itself. The main risk is agreeing to a transaction without understanding what your post-deal ownership and control will actually be.

That matters because percentage ownership can affect several practical issues:

• voting control at shareholder level
• board appointment rights under a shareholders agreement
• dividend entitlements
• drag along and tag along thresholds
• reserved matters requiring special approval
• future fundraising leverage
• founder motivation and retention

In New Zealand, these issues are generally governed by the Companies Act 1993, the company constitution if there is one, and any shareholders agreement or investment documents. The legal mechanics matter just as much as the commercial deal.

Current Shares Versus Fully Diluted Shares

Current shares tell you the ownership position today. Fully diluted shares show what ownership looks like if all likely conversion rights are taken into account.

For example, if your startup has:

• 1,000,000 ordinary shares on issue
• 100,000 employee options on foot
• a convertible note that may turn into 200,000 shares

Your current issued share capital is 1,000,000 shares. Your fully diluted position could be 1,300,000 shares, depending on the instrument terms. A founder who appears to hold 60 percent today may effectively sit closer to 46.15 percent on a fully diluted basis if they hold 600,000 shares and everything converts.

That difference becomes very important before you sign an investment round, promise equity to a senior hire, or negotiate a founder exit.

When This Issue Comes Up

Share dilution usually becomes a live issue at the exact moment a founder is focused on something else, getting money in, securing a key hire, or finalising a deal quickly.

Most New Zealand SMEs and startups encounter dilution in a handful of common situations.

Raising Outside Investment

Angel and venture investors will usually negotiate their percentage ownership carefully. They may price the round by reference to pre-money and post-money valuation, and they may define that calculation on a fully diluted basis.

Before you sign a term sheet, check:

• whether the investor percentage is calculated before or after creation of an option pool
• whether any convertibles are included in the cap table already
• whether preference shares carry special rights beyond ordinary ownership percentage
• whether future anti-dilution protections are proposed

A founder can accept what looks like a reasonable percentage sale, then discover the option pool and conversion mechanics reduce founder ownership more than expected.

Creating An Employee Share Scheme Or Option Pool

Equity incentives can be a smart way to reward and retain staff, especially when cash is tight. But they still affect ownership.

If you reserve a pool for employee options, the economic effect may be felt immediately in deal negotiations even if the options are not yet granted. Investors often want the pool created before their investment lands, which means existing holders absorb that dilution first.

Before you spend money on setup, check the rules of the scheme, vesting terms, leaver provisions, exercise price, and whether the company has authority under its constitution and shareholder arrangements.

Convertible Notes And SAFEs

Convertible instruments can postpone the valuation discussion, but they do not avoid dilution. They simply delay when the exact impact is known.

These instruments often convert at the next equity round, sometimes with a discount or valuation cap. That means founders may not know the final number of shares to be issued until later, but the future dilution is still real and should be modelled early.

This is one reason clean documentation matters. Unclear conversion wording can create disputes about price, timing, or priority.

Adding A Co-Founder Or Strategic Investor

Issuing shares to bring in expertise, contacts, or market access is common. The legal issue is not just what percentage the new person receives, but what rights attach to those shares and whether the issue is in the best interests of the company.

Directors in New Zealand must act in good faith and in what they believe to be the best interests of the company. If the board is issuing shares selectively, the decision-making process should be defensible and properly documented.

Restructures, Buy-Backs, And Exit Planning

Dilution also becomes relevant during internal restructures, partial exits, and buy-back discussions. If one shareholder is leaving or the company is reorganising classes of shares, the fully diluted position can affect price and fairness.

That is particularly important where minority protections, valuation methodology, or pre-emptive rights are written into shareholder documents.

Practical Steps And Common Mistakes

The safest approach is to treat dilution as a cap table, governance, and documentation issue all at once, not just a negotiation about percentages.

1. Build A Real Cap Table, Not A Rough Spreadsheet Guess

A proper cap table should show both issued shares and fully diluted shares. It should also distinguish between share classes and rights.

Include:

• every shareholder and the number of shares they hold
• share class details
• option grants and unallocated option pool amounts
• convertible instruments and key conversion assumptions
• pre-money and post-money scenarios
• the result of each possible funding step

Founders often use a basic spreadsheet at the start, which is fine, but the numbers need to be accurate before you sign. If your calculations change depending on who explains them, the cap table is not ready.

2. Review The Constitution And Shareholders Agreement

Your company documents may restrict how shares can be issued, transferred, or converted. They may also require existing shareholders to be offered new shares first, or require investor consent for certain actions.

Check for:

• pre-emptive rights on new share issues
• director and shareholder approval thresholds
• rules for different share classes
• drag along and tag along clauses
• reserved matters
• anti-dilution rights
• valuation or dispute resolution clauses

This is where founders sometimes create commercial tension without realising it. They promise equity before checking whether the documents allow it.

3. Get The Pricing Language Clear

Small wording differences can materially change dilution outcomes. Terms like pre-money, post-money, fully diluted, issued capital, and conversion discount should be defined clearly in transaction documents.

For example, if an investor is taking 20 percent on a post-money fully diluted basis, that is not the same as taking 20 percent of current issued shares. If the option pool is topped up before completion, founder dilution may increase again.

Ask for worked examples during negotiation. A practical example can reveal a problem that legal definitions alone may hide.

4. Think About Control, Not Just Economics

A founder can be comfortable with a lower percentage until they realise key decisions now require investor approval or a special majority they no longer control.

Before you sign a contract, check whether the proposed changes affect:

• ordinary shareholder voting power
• special resolutions
• board composition
• founder veto rights
• consent rights for future fundraising
• the ability to sell the business later

Ownership percentage is only one part of the picture. Governance rights can matter more than one or two percentage points.

5. Document Director Decisions Properly

Share issues in New Zealand require proper board process. Directors should consider solvency requirements where relevant, the terms of issue, and whether the decision is in the company’s interests.

You may need:

• board resolutions approving the issue
• shareholder resolutions if required by the constitution or shareholders agreement
• subscription or investment agreements
• updated share registers
• new shareholder deeds of accession
• Companies Office updates

Poor documentation can create messy problems later during due diligence, a sale process, or the next investment round.

6. Do Not Ignore Existing Legal Workstreams

A capital raise often sits alongside other legal tasks. If the company is growing quickly, investors may also ask to see key contracts, privacy compliance, trade mark protection, contractor and employee arrangements, and customer terms, especially if you are selling online or scaling nationally.

That does not change the dilution maths, but it affects negotiation leverage and timelines. A clean legal position makes equity discussions easier.

Common Mistakes Founders Make

The most common mistakes are predictable, which is useful because they can usually be avoided.

• Confusing percentage sold with percentage remaining after all dilutive instruments are counted.
• Agreeing to an option pool increase without modelling the impact on founder ownership.
• Assuming a convertible note is harmless because conversion happens later.
• Overlooking control rights attached to preference shares or investor consents.
• Promising equity to staff or advisers before checking internal approvals.
• Failing to update registers and Companies Office records.
• Using inconsistent definitions across the term sheet, investment agreement, and cap table.

If you are a startup preparing for growth, the practical lesson is simple: work out the fully diluted picture before the negotiation gets emotionally or commercially committed.

FAQs

Is share dilution always a bad thing?

No. Dilution can be a sensible trade-off if the company is raising funds, hiring key talent, or bringing in strategic value. The real issue is whether the dilution is understood, priced properly, and matched with a better business outcome.

What is the difference between issued shares and fully diluted shares?

Issued shares are the shares already on issue. Fully diluted shares add in securities that may become shares later, such as options or convertibles, based on the transaction terms and assumptions being used.

Can a New Zealand company issue shares whenever it wants?

Not always. The company must follow the Companies Act 1993, its constitution, and any shareholders agreement. There may be approval requirements, pre-emptive rights, or investor consent rights that need to be satisfied first.

Do employee share options dilute existing shareholders?

Yes, usually once they are exercised, and often economically earlier if the option pool is factored into negotiations on a fully diluted basis. That is why founders should model the pool carefully before grants are made.

Should founders worry more about percentage ownership or control rights?

Both matter. A small reduction in percentage may be manageable, but a change to voting thresholds, board seats, or veto rights can have a much bigger effect on how the company is run.

Key Takeaways

• Share dilution means your ownership percentage falls when new shares are issued, even if your number of shares stays the same.
• Fully diluted shares give a more realistic ownership picture because they include options, convertibles, and similar rights that may become shares.
• Dilution often arises during fundraising, employee equity planning, convertible note deals, and co-founder or strategic investor arrangements.
• The legal position in New Zealand depends on the Companies Act 1993, your constitution, shareholders agreement, and properly approved transaction documents.
• Founders should model both economics and control before they sign, including voting power, investor rights, and option pool impacts.
• Accurate cap tables, clear definitions, and correct Companies Office and register updates can prevent expensive problems later.

If your business is dealing with share dilution 101 and wants help with cap table reviews, shareholders agreements, investment documents, you can reach us on 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.