Email from a recently formed two founders start up:
“Hey, Foundry, when you formed our corporation, I thought we had 10 million authorized shares. Why do we only have 4 million shares each and not 5 million if we are 50-50 owners?”
At Foundry, we frequently receive questions like this.
To start, it is standard to authorize 10 million shares of common stock for a new corporation. Out of the initial authorized 10 million shares, it is also common for the founders to take only between 6-8 million of those shares.
Why leave millions of “authorized” but unissued shares? And, what impact does this have on founders’ ownership?
Authorized shares are the number of shares specified in a corporation’s certificate of incorporation as the maximum number of shares the corporation may legally issue. The number of shares that a company actually issues can never exceed this number, or the excess shares will be invalid.
So, in the case of the company with 10 million authorized shares and two founders who are 50-50 owners, 5 million to each founder would result in 0 shares left for the company to issue without having to amend the articles (a formal process that requires filing with the state).
Well, wouldn’t 4 million shares result in each founder’s ownership at 40% each?
No, the total number of authorized shares is not taken into account in determining ownership.
In the case of the two founders above:
4 million shares to founder A + 4 million shares to founder B = 8 million shares issued
4 million / 8 million = 50%
In the above example, the founders’ shares were the only shares the company currently issued. This doesn’t take into account shares reserved under a stock option plan. Those “reserved” shares are not issued, but are taken into account when calculating a founder’s “fully diluted” ownership percentage.
The simple fact is that authorized shares are just that: authorized. Until the corporation issues them or formally reserves them under a stock option plan, these possible shares are not taken into account in determining ownership.
So, what are the benefits to not issuing all the authorized shares?
The main benefit of leaving available authorized shares is that it creates some room for:
- adoption or increasing the size of an option pool;
- issuance of additional shares; or
- some extra shares to cover for different circumstances, such as a convertible note round where you must have sufficient shares to cover a possible conversion of the notes into common stock.
The corporation could amend the articles to authorize more shares, but it is better to just leave a little room from the outset.
The attorneys at Foundry Law Group have significant experience handling formation and securities issues for our clients. Contact us with any questions about your equity or company’s shares, we are here to help!