If you're planning to start or have started a startup, one of the first things you'd probably like to know is how many shares you should have. This is valid because aside from having business ideas and building products, corporate structuring is one of the crucial aspects of running a startup.
The corporate structure of a startup answers the "how many shares should a startup company have" question, affects the type of investors it attracts, the amount of money generated from investments, tax regulations, stock options for employees and founders, and many other things.
There is some misconception about how many shares a startup company needs. Some believe that more shares mean a more stable company, while others believe that 1 unit of shares can be all you need and will do just fine.
There is no one-size-fits-all answer to the "how many shares should a startup company have" question. However, because there are many use cases for the shares, you should have enough shares at the start of your company. For a robust understanding, we will examine why startups need shares.
Why You Need Shares in a Startup
There are many reasons why you need shares as a startup company, so it's important we cover the fundamentals before discussing the details of shares.
1. To Raise Funds
You need money to set up and get going at the company's start. Even if you decide to bootstrap and use your resources at the start, there comes the point where you may need external funding.
According to Fundera, equipment costs for startups can range anywhere from $10,000 to $125,000. Aside from getting your equipment, you’d also need to professionally set up your office, carry out your daily operations that will require money, amongst other things. Hence, you may need more than $10,000 to $125,000.
One of the common ways of attracting external funding is through shares. The investors in your company get shares in return for the fund provided to you to run your company. Without shares, how can you raise funds?
2. To Provide Stock Options for Employees
When many startups begin operation, their employees usually sacrifice a lot, from spending more time than necessary at work to combining two or more roles. Early-stage employees can be the difference between success and failure in a startup.
Some startups pay less than the acceptable market value for their employees due to a shortage of funds. Also, it takes a certain amount of belief and grit to stay with a startup from day one.
Therefore, to reward these employees, some startups offer them stock options. This means that these employees own little part of the company and can sell these stock options in the future.
It is important to note that there are numerous reasons why a startup issue shares as stock options to employees, and it is not limited to the reason given alone. Other uses of employee stock options are to get key hires over the line and to reward the loyalty of employees.
The Basics of Startup Corporate Structure
We cannot determine the appropriate number of shares for a startup without understanding the basics of corporate structuring concerning shares in a startup. To help you here, we have covered the different types of share classes below.
Types of Shares in a Startup
Authorized shares refer to the number of shares a startup company or corporation can distribute to its investors or shareholders at inception. When the startup is incorporated, it creates a charter or an article of incorporation it will submit to the appropriate government agency.
This charter contains important information or details about the corporation, part of which is the number of authorized shares. In simpler terms, the authorized shares limit the number of shares a startup company can distribute or issue.
Allotted shares are shares that are selected for issuance to shareholders and investors. These shares are not distributed or issued but instead earmarked for distribution.
Outstanding or Issued Shares
When allotted shares get distributed, they become issued shares. It is important to note that the issued shares cannot be more than the authorized shares.
This portion of the authorized shares cannot be issued to investors and shareholders because it is restricted. The purpose of restricting these shares is to use them for other things, which includes employee incentives. The total number of a company's shares available for trading is known as float.
Startup Structure and Shares Terminology
Having understood the types of shares, let us discuss some important terms regarding startup corporate structuring and shares.
The franchise tax is a form of taxation that companies and corporations are liable to pay to the government. This tax is determined by the total number of authorized shares that a company has.
Authorized Unissued Shares
As the name suggests, these shares have not been issued to any shareholder or investors. They are a part of the restricted shares and are used for the startup's future growth.
This refers to the amount of money paid for a share. As a general rule, companies shouldn’t issue their shares for less than the market value of that share.
In the charter or article of incorporation created at the point of incorporating the company, the startup states the lowest price per share. This price is the per value of the shares. It is the price that startup founders buy back their shares after the incorporation.
Also known as common stock, they are shares issued to the public or employees. There are no special rights allocated to these shares.
These are special types of shares and are issued to investors at a special round and price. This is because these shares confer special rights and privileges on the investors.
These rights often include investors being distributed their share of the business first, before anyone else, including the founders.
Preferred stock may sound bad for the founders, but investors are often offered equity on these terms due to the risk they are undertaking when they receive an amount of equity for investing in a business.
How Many Shares Should a Startup Company Have?
As much as there is no specific answer to this question, "how many shares should a startup company have," the common answer that law firms and business attorneys advise is 10 million units of shares. This is generally the most used amount of shares that a startup begins with.
However, you should not distribute or issue all 10 million shares to shareholders and investors. Of the 10 million, the startup company should reserve some as equity, and some of the shares should go into the employee stock option pool. This pool is very important as it helps the startup provide needed compensation for new hires and future business development.
You should also note that the shares issued or reserved in the pool are common shares and the ones issued to investors on share certificates are preferred shares. When the company goes public, all of these preferred shares will be converted to common shares during the initial public offering.
To get more preferred shares, investors would have to wait for future funding rounds when the company authorizes the shares again. Another important thing to do at the point of determining the total shares that the company would have is to determine how to distribute shares among founders in cases where there are more than one.
While distributing or deciding on how to distribute shares among founders, it is important that the founders hold back from allocating or issuing the shares reserved in the founder's stock. This is due to the tendency that senior employees in the company may prefer to own some stake in the company as it develops.
An acceptable sharing formula is 80% to 20%. 80% of the common shares go to the founders, investors, and advisors (if any), while up to 20% goes into the employee stock option pool. Primarily, the founders should have about 50%, the investors should retain 20%, and the advisors should have up to 10%.
How your business does this in reality may vary - there is no right or wrong answer in regards to the employee stock option split, as long as it works for your employees and founding team. Check out the Mailchimp story to get an interesting example of the different approaches businesses take.
You do not have to worry about preferred shares when deciding the number of shares the startup has. This is because preferred shares come into being when companies start raising money during funding rounds and not during incorporation.
You cannot authorize and issue preferred shares until you have raised money from investors in one of the financing rounds. During the closing part of the financing rounds, the board of directors will approve the authorization and issuance of a new class of preferred shares when the company starts a future round of equity financing.
If you are planning on raising funds from venture capitalists, you will need different classes of preferred shares.
Why 10 Million?
This is one of the questions that usually comes to mind when reading about corporate structuring. Of all the random numbers of shares to settle for, why choose 10 million?
Well, the answer is simple. There is nothing special about 10 million. The idea is to have enough shares to start your company. However, there are certain advantages that 10 million shares offer that you may not get with other random numbers.
First off, it allows for easy division and visualization. Being easily divisible by 10 makes 10 million the best random number to make your startup company's shares.
For instance, let us assume that the number of shares authorized is 1000 instead of 10 million. In this case, it becomes difficult to issue granular equity stakes to your employees. These stakes are supposed to be a part of their equity compensation.
Another reason the number "10 million" works perfectly for a company's shares is the psychological side when it comes to a stock options pool for employees. Would you rather take 1 unit of company shares at a higher price or 10,000 shares at a lower price? The answer for most people is taking a lot more units of shares at a lower price.
It feels way better to say "I own 10,000 units of shares" than to say "I own 1 unit of shares", regardless of the price. You should also remember that shares at a lower price translate to a purchase price when the shares are finally cashed in.
Therefore, many employees want a higher quantity of shares in their stock options. This wish becomes difficult to satisfy if there are 1000 shares as apposed to 10 million shares.
An important part of corporate structuring for a startup is determining how many shares a startup should have. When a company gets this right, it sets the tone for raising impressive amounts of money for investments and having enough shares as stock options for employees.
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Once you’ve sorted out how many shares your startup has, feel free to check out our extensive options for pitch deck templates to help you raise the funds needed to accelerate your business.
FAQs about Startup Shares
Can a startup alter its authorized shares?
After some time, a startup company can change the number of its authorized shares. However, before doing this, the company must inform the shareholders and call for a vote. When the company finally changes the number of authorized shares, existing shareholders are not entitled to receive compensation or more shares.
Can a company issue more shares after initial issuance?
A company can issue more shares than it has already issued under special circumstances. However, some conditions must be met.
Firstly, the company must have plans to increase the number of authorized shares or have enough authorized unissued shares. After this, the company must also get the board of directors' approval before issuing the extra shares.
Lastly, the company must be able to follow the securities regulations stipulated by the state and federal governments concerning the issuance of the extra shares.
Can the company issue more shares than the authorized shares?
A company cannot issue more shares than the number of authorized shares available. Doing this is a direct contravention of the federal and state securities regulation on issuing shares. According to securities law, such shares' issuance is considered null and void.