Of the many decisions that must be made at the inception of a new company, perhaps among the first considerations an entrepreneur must make is how many shares to issue and authorize. The number of shares your startup authorizes will play a critical role in allowing you to raise capital, attract investors, and structure ownership. But what is meant by "authorizing shares," and how do you determine the right number for your business? In this article, we are going to talk about the conceptual background of share authorization, why it is such an important thing, and go through some real ways to help you make informed decisions concerning your startup's equity structure.
Understanding Authorized Shares
It's relevant to clearly explain the concept of authorized and issued shares as foundational ideas before jumping into the details of the figures involved in operating the equity of your startup.
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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.
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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.
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.
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:
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Convenience and Calculations: When one has 10 million authorized shares, this makes calculations easier. For example, if you are starting with two founders, each owning 50 percent of the company, it would be easy to allocate 5 million shares to each founder.
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Investors' Comfort: Investors are more accustomed to a company that has a high number of shares, making it 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.
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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.
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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. This means that it may take a certain length of time or specific achievements before the full allocation becomes accessible to the founders themselves.
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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 can be a great incentive that will align the motivations of the employees with that of the business 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. This helps you attract and retain talent while balancing the interests of founders and early investors.
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:
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Common Shares: The default kind of share class or the standard ownership of the company. Holders of common shares receive dividends and voting rights, with their shares ranking last during liquidation events.
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Preferred Stock: Investors commonly prefer preferred stocks because they come with privileges like guaranteed dividends or liquidation preferences upon sale or liquidation of the company. These shares may also 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 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 helps maintain momentum and attract investors quickly.
However, you don't want to over-authorize a large amount of shares at the beginning because this would dilute ownership for other stakeholders without a valid reason. It's essential to maintain a balance between flexibility and control.
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 starting point, the answer really depends on your company's specific needs and goals.
Entrepreneurs need to consider:
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The current ownership structure and how much equity to assign to founders, employees, and early investors.
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Future fundraising plans and the number of shares needed to accommodate new investors.
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The balance between flexibility and control—issue sufficient authorized shares, but not too many.
Remember: there is no one-size-fits-all solution. Consult legal and financial advisors to tailor your number of authorized shares, ensuring your equity structure supports both short-term goals and long-term growth. Flexibility is key; be prepared to adjust your approach as your startup evolves.
Navigating the complexities of share authorization and equity distribution can be challenging, but it doesn’t have to be. At IncUnit, we provide expert guidance to help you make informed decisions tailored to your startup’s unique goals. From advising on share issuance strategies to preparing for future fundraising rounds, our team is here to support you every step of the way. Get Started Today! Contact Us for personalized advice and secure your startup’s future with the right equity structure.