How many shares should be authorized in the certificate of incorporation?
Takeaway: For most startups, starting out authorizing 10mm shares of Common Stock and issuing 8mm of those to the founders is the right approach.
When forming a new corporation, one of the decisions that must be made is how many shares to initially authorize in the company's Certificate of Incorporation.
What are Authorized Shares?
Authorized shares are the maximum number of shares that a corporation is authorized to issue. This number is typically set forth in the company's Certificate of Incorporation. The number of authorized shares is important because it determines how many shares the company can issue to investors, employees, and others.
Factors to Consider
When deciding how many shares to initially authorize in the Certificate of Incorporation, there are several factors to consider. These include:
The company's financing needs: If the company plans to raise a significant amount of capital early on through equity financing, it may need to authorize a large number of shares in order to have enough shares available to issue to investors. Typically though, increasing the authorized shares is done separately in connection with a financing.
The company's growth plans: If the company expects to experience rapid growth in the future, it may want to authorize a larger number of shares in order to have flexibility in issuing additional shares to hire employees to support that growth.
The company's industry and competition: The number of authorized shares can also be influenced by the company's industry and competition. For example, if the company is in a highly competitive industry, it may need to authorize a larger number of shares in order to compete for employees and service providers effectively.
Common Approaches to Authorizing Shares
There are multiple approaches that companies take when authorizing shares in their Certificate of Incorporation:
Standard Approach: The company authorizes a moderate number of shares, such as 10 million shares, which is sufficient for most early-stage companies. Of those 10 million shares, 8 or 9 million are issued to founders and the remaining 1 or 2 million is reserved for issuance to employees and service providers although these shares do not have to be issued at all. This is what most of my clients do.
High Share Count Approach: The company authorizes a large number of shares, such as 100 million shares, in order to have flexibility to issue additional shares to support rapid growth. Having this amount of shares authorized can be a useful tool in recruiting employees and service providers as it allows the company to issue them larger numbers of shares, which can be perceived as more valuable (even though the economic value of those shares is the same).
From a mathematical perspective, it does not matter how many shares you have outstanding. What matters is the proportion of the total shares that you own. For example, owning 1 share with 10 shares outstanding (10%) is the same as owning 10,000,000 of 100,000,000 shares outstanding (10%).
Conclusion
The number of shares to authorize in a company's Certificate of Incorporation should be carefully considered based on the company's financing needs, growth plans, ownership structure, industry and competition, and future financing rounds. I typically recommend startups involve their legal counsel to determine the appropriate number of authorized shares for the company's specific situation.