Of the many decisions to be made at the inception of a new company, one of the first considerations for an entrepreneur is determining how many shares to issue and authorize. The number of shares your startup authorizes is crucial for raising capital, attracting investors, and structuring ownership effectively. But what does ‘Startup Authorize’ mean in this context, and how do you determine the right number of shares for your business? In this article, we’ll explore the concept of share authorization, why it’s vital for your startup’s success, and provide actionable insights to help you make informed decisions about your equity structure.
Understanding how to effectively startup authorize shares is crucial for establishing a solid foundation for your company’s growth.
One key aspect to consider when deciding how many shares your startup should authorize is understanding the tax implications of starting a new business in the USA. This knowledge can significantly influence your financial planning and share distribution.
Moreover, if you’re considering starting a small business at home, it’s crucial to understand that share authorization isn’t just about numbers; it’s also about strategy. The right number of authorized shares can help you attract potential investors by giving them a clearer picture of your company’s equity structure.
In addition to share authorization, there are other important steps involved in launching a successful startup. For instance, understanding how to register a trademark in the USA can protect your brand identity. Similarly, knowing how to get an EIN (Employer Identification Number) is essential for tax purposes.
As you navigate these complexities, remember that every decision you make should align with your overall business strategy. Whether you’re deciding on share authorization or exploring other aspects of starting a business, it’s important to gather as much information as possible and consult with professionals if needed. If you’re interested in learning more about various aspects of starting and running a business, our blog offers a wealth of information on topics ranging from how much will it cost to start an LLC in 2023 to the benefits of side hustles and understanding the key differences between LLCs and C-Corps.
Understanding Authorized Shares
It’s relevant to clearly explain the concept of authorized shares and issued shares as foundational ideas before jumping into the details of the figures involved in operating the equity of your startup.
- Issued Shares refer to the number of shares a company has actually given to the shareholders. The amount of issued shares is always less than or equal to the number of authorized shares.
- Authorized Shares refers to the maximum number of shares that can legally be issued by a company, usually as defined by the Articles of Incorporation. Keep in mind that this is a limit rather than a target and can later be changed if so desired, though doing so may require shareholder approval.
Why does that matter? Having enough authorized shares means your business has the runway it needs to issue shares when necessary—be it for new investors, stock option plans for employees, or future fundraising rounds. At the same time, you would not want to over-authorize shares as that may dilute the ownership of present shareholders without adding much value to them. Understanding the distinction between authorized shares and issued shares is crucial for effective equity management in your startup.
How Many Shares Does a Startup Need?
How many shares should a startup authorize? There is no “one-size-fits-all” answer, but common ground for many startups is the starting point of 10 million shares. Why is this number so popular, and what are the advantages?
The Standard Number: 10 Million Shares
Many startups authorize about 10 million shares in the outset. This is considered a number that practically works well, where there is great balance between flexibility and simplicity.
Pros of 10 Million Shares:
1. Convenience and Calculations: When one has 10 million authorized shares, this makes calculations easier. For example, if he is starting with two founders, with each owning 50 percent of the company, then it would be really easy to allocate 5 million shares to each founder.
2. Investors’ Comfort: Investors are more accustomed to a company that has a high number of shares. Because this will make it much easier to negotiate equity stakes during fundraising rounds. Giving investors, say, 10-20% of the total number of shares in your company, depending on the stage and negotiations, would be easier if there are millions of shares in circulation.
3. Ability to Raise Additional Funds in the Future: By allowing a large number of shares at the outset, you will have ample room to later issue additional shares without constant changes to the articles of incorporation.
Remember that the authorized number of shares does not necessitate the issuance of the shares immediately; they can remain unissued until such time as you need them.
Share Issuance Strategies for a Startup
Once you have determined how many shares to authorize, you then need to consider how to distribute those shares. Equity distribution is a very important aspect of any startup, and the way you decide to allocate shares can have a significant effect on your company’s ability to attract the right talent, investors, and partners.
1. Founder Shares vs. Employee Stock Options
When it comes to structuring equity in your startup, there is one major decision that needs to be made: how the pie is cut between founders and employees.
- Founder Shares: Those shares initially given to the founders of the company. Founder shares, in most instances, carry specific rights, including voting rights, but can be subjected to a vesting schedule. What this means is that it may take a certain length of time, or even specific achievements in milestones, before the full allocation becomes accessible to the founders themselves.
- Employee Stock Options: In any startup, a definite percentage of their shares is dispensed to Employee Stock Options to attract and retain quality talent. Employee Stock Options give employees the right to purchase company shares in the future based on a predetermined price. This shall prove to be a great incentive that will align the motivations of the employees with that of the business house over a long period.
A common practice is to reserve 10-20% or so of the company’s overall shares for the employee stock option pool. Such that you are capable of attracting the best talent and retaining your employees, but you also have to balance this in such a way that founders’ and early investors’ interests are taken care of in the process.
2. Investor Expectations Regarding Shares
When raising funds, it is critical to understand what investors expect about share types. There are generally two kinds of shares that investors may be interested in:
- Common Shares: The default kind of share class or the standard ownership of the company. Normally, holders of common shares receive dividends and voting rights, with their shares ranking last during liquidation events.
- Preferred Stock: Investors commonly prefer preferred stocks for the simple reason that they come with privileges accorded to them, such as guaranteed dividends or liquidation preferences upon sale or liquidation of the company. The shares may further have the right to convert into common shares under certain conditions.
You may be asked to provide preferred shares in fundraising rounds to early-stage investors seeking a return on their capital. However, common shares are most likely going to be the major share type for most of your employees and founders.
Consideration of Future Fundraising for Startups
Determining how many shares to authorize should also consider not only present needs but future fundraising opportunities. Additional shares will be issued in that respect as your startup grows and raises more capital.
Having enough authorized but unissued shares ensures you will not have to go through the legal process of increasing your authorized shares right in the middle of a fundraising round. This is important in order to keep momentum going and to attract investors within the shortest time possible.
Yet, there’s a sort of fine balance. You certainly don’t want to over-authorize a large amount of shares at the beginning of your startup, because this would dilute ownership for other stakeholders for no valid reason. Meanwhile, you still have to leave some room for growth while maintaining equity within the company at reasonable levels.
Planning is not just about today but also about anticipating future growth. Set your goals while maintaining flexibility and leaving room for expansion.
– Peter Drucker
Conclusion: How to Balance Share Authorization for Your Startup
So, how much should your startup authorize? While the 10 million shares standard is a popular and accepted starting point, the answer really depends on your company’s specific needs and goals.
Entrepreneurs need to take into account:
- The current ownership structure and how much equity to assign to founders, employees, and early investors.
- Future fundraising plans and the number of shares needed to accommodate new investors.
- The balance between flexibility and control issue sufficient authorized shares, but not too many.
💡 Remember: One-size-fits-all solutions do not work. You need to consider your specific needs with the help of legal and financial advisors to tailor the number of authorized shares so that your equity structure supports both your short-term goals and long-term growth. Flexibility is key; thus, be prepared to adjust your approach as your startup evolves.
