How Many Shares To Authorize?

I am frequently asked this question: How many shares should my startup authorize in its charter (its Articles or Certificate of Incorporation)?

The trite, short answer is—authorize enough.  The longer answer is more nuanced, and basically boils down to—authorize enough to cover founder stock issuances (obviously), the equity or stock plan pool, reasonably foreseeable preferred stock issuances, and some headroom to cover the reasonably foreseeable growth of the Company.

Like other legal framework questions in starting a company, one of the tricks is to build a legal structure which is ready to accommodate growth.  As your company grows, if you have the right legal structure in place, you will have less legal work that you have to do along the way to keep up with the growth. (For example, authorize enough shares so that you don’t have to amend your charter later on to authorize more. Authorize blank check preferred so that you don’t have to amend your charter to close your first preferred stock financing, etc.)

Authorized shares are the  shares a company is authorized to issue, not the number of shares the company will necessarily issue. For example, you might authorize 10 million shares, but only issue 2 million.

“Authorized but unissued shares” are shares that are authorized but not issued. In the example just given, a company with 10 million shares authorized, but only 2 million shares issued, the “authorized but unissued shares” would be 8 million.

Why would you authorize more than you might issue? Because you want head room. You want the shares available in case you need to issue them.

In the above example, you might need that remaining 8 million authorized, but unissued, shares for things like:

  • common shares that might be issued on the conversion of preferred shares that are issued later (if you sell 2M shares of preferred stock, you will need at least 2M shares of common stock available and reserved for that preferred to convert into later);
  • shares that will be issued on the exercise of stock options or warrants issued later;
  • shares that will be issued pursuant to other forms of compensatory equity awards (perhaps outside the plan options);
  • shares which might be issued in future financing transactions; or
  • shares which might be issued in forward stock splits (especially if you grow spectacularly fast).

Sometimes founders get nervous and want to make sure that they are forever going to control the entity – and thus if 10 million shares are authorized, they want 6 million issued to them as founder shares – to make sure that no one in the future can obtain a majority of the shares without their consent.

This doesn’t make sense and can be problematic for a couple of reasons. First, if you authorized 10 million shares, you probably included in that authorized share figure some number of authorized preferred shares, such as 2 million. So, if you authorized 10 million shares overall, and you split that between 8 million common and 2 million preferred, 2 million of the common should be thought of as set aside for the potential conversion of the preferred, thus leaving only 6 million common theoretically available – all of which you would have issued in the above example to the founders– leaving no room for an option pool.

Don’t be afraid to have headroom for future growth.

 

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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  • http://www.venturedocs.com Bo Sartain

    I’m always amazed when I see companies issue every share that they authorize in the initial articles or certificate of incorporation to the founders, without leaving any authorized shares to play with.

    I think another driver of how many shares to authorize is based upon the anticipated pre-money valuation that a company wants to receive in a seed or angel financing. Many investors like to structure the first round of financing at, or roughly at, $1.00 per share. Because the share price is determined by dividing the negotiated pre-money value by the number of shares outstanding (inclusive of the company’s Equity Incentive Plan), it can give the company guidance as to how many shares to initially issue (inclusive of the Equity Incentive Plan) and therefore how many to authorize.

    Example, If a company wants to raise first capital at a $3,000,000 valuation, the company has 3,000,000 shares to allocate to the founders and the Equity Incentive Plan in anticipation of pricing it’s first financing round at $1.00 per share. Given your guidance in the article, the company needs additional authorized to cover the equity financing or whatever else may come its way. I think the minimum the company would want to authorize in this scenario would be 6,000,000, but I would probably advice going to 10,000,000.

    • http://startuplawblog.com/joewallin Joe Wallin

      That’s exactly right Bo. I give the exact same advice. When trying to figure out how many shares to issue, make a guess as to your likely pre-money value on your first raise and issue that number that would put your price per share in that round at about $1.00 a share. Thanks for your great comment.