On a couple of occasions, I have worked with founders whose corporations (prior to retaining me) issued a small number of their authorized shares.
In one instance, four founders formed a corporation that was authorized to issue 50,000 shares, but had issued (to themselves) fewer than 400. They asked me to help reallocate shares among them because, as time had passed, they saw that their respective contributions to the business differed from what they initially had expected.
We needed to avoid any purchase and sale of shares for tax reasons. I prepared a voting rights agreement by which two of the founders gave a portion of their voting rights to the two other founders. Because the number of shares issued was so small, we had to express the transferred voting rights in terms of unusual fractional portions of shares to achieve the desired allocation.
In a more recent situation, the sole founder created a corporation with 1,000 authorized shares but issued only one share to himself. The founder wants a friend to invest funds in exchange for ten percent of the equity. This presents a somewhat awkward situation, in that the straightforward way to to accomplish the desired end (without changing the founder’s current share ownership) would be to issue the investor 0.11 share (a small fraction of one share).
There are ways to make the arithmetic somewhat more palatable, such as first having the founder acquire more shares, or having the corporation split its shares. However, the former may have undesirable accounting or tax implications (which are being researched), and the latter would incur legal fees and expenses that could have been avoided if appropriate legal counsel had been sought up-front.
So, how many shares should be authorized? I typically have my clients’ corporations authorize 10,000,000. (Caveat: If you are forming a Delaware corporation with a large number of shares, be sure to specify a low par value, such as $0.0001 per share, to avoid having to pay excessive annual fees to the state. See In Delaware, No-Par-Value Can Cost a Bundle and How To Calculate Franchise Taxes.) There are two reasons for the large number:
- To allow plenty of flexibility in allocating shares among founders and other shareholders.
- To make employees or contractors who receive shares or options feel like they have received something of greater value. I realize this is a bit silly, but an individual will be more impressed receiving 10,000 shares rather than 100 , even if, in both instances, the number of shares represents the same percentage of ownership.
And how many of the authorized shares should be issued to the founder(s)? I find this varies among clients, but typically is between 50+% and 100%. Toward the low end of the range, the founders can maintain voting control while having many shares reserved for investors, employees and contractors. The high end of the range is appropriate for founders who expect never to have to share their equity interests with anyone.
- Can a Corporation Issue More Shares than are Authorized?
- Must a Corporation Issue All Authorized Shares?
- Should My Corporation Provide Stock Certificates to Shareholders?
Dana H. Shultz, Attorney at Law +1 510-547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.