Ask the Expert: What is a good number of authorized shares?
By ANDREW GROSVENOR of Merritt & Merritt
Sometimes starting a company is as easy as filing a few forms and paying a fee, but in the startup world some common questions come up. Many founders begin the paperwork, but get stumped when they need to list a number of authorized shares and par value. What does “authorized” mean? What is “par value”? What’s a good number of shares? 100? 1,000? 10,000,000?
There’s no single right answer, but you can save some time (and an additional filing fee) by thinking about these issues up front. Here are some factors to keep in mind.
First off, consider your initial ownership structure. Are you a sole founder? Do you have co-founders, partners, investors? Next, think about your plans for the company. Will you be seeking outside investment? Will you be issuing stock to employees and consultants? How much control over the company do you want to (try to) retain?
Once you can answer these questions, you’re in good shape to get started.
Here are the basic definitions: “authorized” stock is the maximum amount of stock that the company is allowed to issue (this can be changed by amending your filings with the state). Stock is “issued” when the company issues or sells it to an owner.
On one end of the spectrum is the sole founder who intends to grow the business from the ground up, without taking outside investment or issuing equity to employees.
In this case, it really doesn’t matter much how many shares a company has. The company could have only a single share of stock issued to the founder, who would own the whole company just as much as if she had issued herself 100 million shares.
At the other extreme, there may be multiple founders, investors, employees and consultants involved at the startup stage. In this case you should be working with a lawyer (and odds are you already are).
A good rule of thumb here is to authorize enough shares to provide adequate granularity of ownership. A common number is 10 million, which provides more than enough granularity without the need to create fractional shares. Another (somewhat frivolous) perk of having so many authorized shares is that employees tend to be more excited receiving 50,000 shares (0.5 percent of a company with 10 million issued shares) than they are receiving 500 shares (0.5 percent of a company with 100,000 issued shares). There’s no real world difference, but sometimes psychology is everything.
At formation, it’s a good idea to leave some overhead of authorized shares for future use. How much is a judgment call, and the numbers may vary depending on your situation.
Here is a sample breakdown: 10 million authorized shares, 4 million shares issued to founders (80 percent), 1 million shares reserved for an equity incentive program for employees (20 percent).
This leaves 5 million authorized shares that could be issued in the future (but note that issuing these shares will dilute existing ownership). Planning for an incentive program up front is important because accounting becomes difficult when a company has to authorize new shares or dilute existing ownership for each employee that comes on board.
There are a couple of alternative options for incentive programs as well. A company could create a separate class of non-voting stock to issue to employees. This is useful where founders want to retain full voting control of the company.
Another option is phantom stock, in which a company issues a future cash grant to an employee in an amount to be determined by the company’s stock value.
Phantom stock can be a tricky concept, but basically it provides for the same economic risk/reward as stock ownership, but without owners giving up any voting control. Any stock issued under an equity incentive program should be set up to vest over time under a restricted stock agreement between the company and each employee. Vesting provides incentive to stay with the company and increase its value, and can have some tax advantages for employees as well.
Which brings us to par value. Par value is the initial price of the stock, and doesn’t actually mean much after the company is up and running.
Generally, initial par values are set at something like $0.00001 per share, which allows a founder purchasing the first 2 million shares of the company to pay only $20 for that interest.
If you are incorporating in Delaware, talk to your accountant — some calculation methods can result in a hefty tax bill based on the initial authorized shares and par value.
Andrew Grosvenor is an associate attorney with Merritt & Merritt, where he advises growth companies of all sizes and loves helping startups start up. He is on Twitter at @drewgrosvenor or at Merritt-Merritt.com. He is also easy to find most days at Alpha Loft in Manchester.