Imagine launching a rocket—the precision needed, every calculation critical. Similarly, startups face pivotal questions from the get-go, and one that often looms large is, how many shares should a startup have?
It’s not mere numbers; it’s the DNA of your company’s future, dictating the rhythm of innovation, investment influx, and founder control.
Seamlessly intertwined with your startup’s valuation, equity distribution breathes life into your corporate governance, attracts investors, and carves the path for your potential IPO.
Understanding the vesting schedule and crafting an equitable capitalization table are as vital as the product or service you’re bringing to life.
By the close of our exploration, you’ll have unraveled the covert intricacies of share allocation, grasped the subtleties of stock issuance, and the implications of employee stock options (ESOP).
Moreover, you’ll stride through the legal corridors of shareholder agreements and decode the enigma of maintaining harmony among minority vs majority stakeholders.
Every sentence is a step closer to mastering the equilibrium of shares—steer through with us, and emerge prepared to chart your startup’s course.
5 common types of startup company shares you should know about
Before you settle on the ideal number of shares for your company, you must first understand the different types. Below are the 5 common types of startup company shares you should know about
What are authorized shares?
Authorized shares are the shares you’re legally allowed to issue. They include both issued and unissued shares.
When you authorize several shares, you don’t have to issue them all at once. Authorizing them simply gives you the right to issue these shares. But don’t worry if you don’t authorize enough shares early on. You can always authorize more later, albeit for a fee.
What are allotted shares?
Allotted shares are those you plan to issue to shareholders and investors. While they aren’t distributed yet, you have them listed for issuance.
What are issued shares?
As the name suggests, issued shares are those you’ve distributed to all of your stockholders. They can never exceed the number of authorized shares – this is legally prohibited.
What are outstanding shares?
Outstanding shares are all issued shares currently held by investors. When you buy them back for your company, they aren’t considered outstanding anymore.
These shares include restricted shares belonging to institutional investors and company officers.
What are restricted shares?
You can’t issue restricted shares to investors or shareholders. Although they are authorized shares, you set them aside for other purposes. For example, you can use them as employee incentives. The total number of shares ready for trading is called float.
To sum up, your authorized shares include all issued, allocated, and unissued but authorized shares.
While a certain company can afford to authorize an endless number of shares, early-stage startups must be more careful. To maintain stability, they should decide on a set number of shares at the beginning.
If they have to, startup founders can authorize additional shares later. However, the majority of shareholders must vote in favor of this decision.
Common vs preferred shares – what’s the difference?
When issuing shares, you can issue two different types of shares – common and preferred.
Sometimes called common stock, common shares target your employees and the general public. They give their holders no special rights.
On the other hand, preferred shares or preferred stock give their holders additional privileges. They are thus superior to common shares. You’ll likely issue these types of shares at special rounds and for special prices.
Preferred shares generally go to investors who helped fund the startup. On the contrary, the common stock goes to its founders and employees. Certain liquidity events might turn preferred shares into common ones. Some examples of such events are the initial public offering and acquisition.
How many shares should a startup have and why?
This question has no clearly defined answer. No law forces you to select a specific number of shares.
However, there are recommendations you can follow. Some institutions recommend starting with 10 million share units. Many startups follow this advice.
Choosing the 10 million option offers several advantages. Firstly, you’ll never have to deal with fractions of shares. It will also lead to a lower price per share. If your startup is worth 1 million dollars, then issuing 10 million shares sets the price at 10 cents each. But if you issue just 10,000 shares, then each share will be worth 100 dollars.
Thus, choosing 10 million shares creates a better psychological effect. Everyone loves low prices and investors are no different. When you set the price at 10 cents, they will be much more inclined to buy your shares.
Startups should also keep a portion of their company to offer employees stock options and equity incentives. This employee stock option pool consists of reserved shares. Most startups choose to reserve 10 to 20% of their shares for this purpose.
The impact of ownership breakdown
When it comes to settling on the minimum and the maximum number of shares, you have free rein. You have no legal obligations to settle on any concrete number. How you divide your shares is entirely up to you.
However, each stockholder represents a portion of your company. From this perspective, the number of your shares does matter.
Suppose you issue 10,000 shares. 5 000 of them then represent half of your company’s equity. If you start with 10 million shares, then 5 million will make out half your startup equity. Though the individual prices are different, the overall value remains the same.
Most startups also choose to preserve up to 20% of their shares for employee incentives.
So how many shares should your startup have? And does the distribution even matter?
Properly distributed shares offer your company the following advantages.
Impact on prospective employees
You can offer a portion of your startup equity to your employees as a reward. This can motivate them to remain in your company.
Impact on investors
We don’t recommend setting the price per share higher than 1 dollar. Just like anyone else, investors like cheap offers. Setting the price per share low creates a powerful psychological effect that will sway them to buy your shares.
On the other hand, you shouldn’t set the price too low either. Investors associate prices below 10 cents with high risk.
The math behind the reasoning
Most startups have a company value between 1 to 5 million dollars. Holding some shares in reserve can make for a powerful employee incentive while investors prefer to buy shares for cheap.
Based on these facts, you should authorize 10 million shares. Since your option pool should represent 20% of your shares, you should hold on to 2 million of them. You can issue the remaining 8 million as you see fit.
A million-dollar company will start with a 10-cent price per share. A 5-million-dollar one would have an initial price per share of 50 cents. When an employee gets a 1% option grant, they receive 100,000 shares. Though it doesn’t seem like much, it holds great value.
Keep in mind that you can rearrange your share distributions later. These decisions are not final and you can alter them whenever you wish.
FAQ On How Many Shares Should A Startup Have
What’s the ideal number of shares a startup should issue?
The “ideal” tally doesn’t exist. It’s about clarity in your capitalization table and future goals.
For starters, a common approach could be issuing 10 million shares, where founder equity remains flexible, and there’s room for future investors. Your chessboard, play wisely.
How does share allocation affect a startup’s valuation?
Allocating shares is a valuation dance. Investor equity stakes can soar or plummet based on your share distribution.
Remember, your pre-money and post-money valuations get deeply impacted. Every slice of the pie given today reframes your startup valuation tomorrow.
What determines the number of shares a startup has available?
Your authorized capital sets the ceiling. It’s your maximum share arsenal, dictated by your company’s bylaws and largely, your ambitions.
Peering into the future and scaling the stock option pool for employees is a wise lookout. Investor expectations also play a lead role here.
Should a startup’s shares be equally divided among founders?
Equal? Rarely. Contributions vary, so do stakes. It boils down to roles, commitment, and risk – a negotiation table staple.
Reflect on long-term engagement and skill importance. Founder shares need not be even, but mutually agreed upon and justifiable.
How do you decide the appropriate share value for a startup?
It’s more art than science. Initial valuations become subjective. Focus on the business model, market potential, and the investment round you’re in.
Use benchmarks from similar startups, but pair it with a good hunch of what the future could bear.
What’s the significance of common vs preferred stock for startups?
Common stock is usually for founders and employees – think voting rights but higher risk. Preferred stock is investor territory.
It’s about preference in dividends and upon exit strategy events, a security blanket of sorts for those pouring capital into your ambitions.
How should startups handle share dilution during investment rounds?
With a stoic stance. Share dilution isn’t all doom; it’s an equity financing trade-off. Bringing a heavy-hitter investor aboard?
Your piece of the pie shrinks, sure, but the pie grows. The aim? Overseeing that your equity value post-dilution is worth the investor’s check.
How can startups protect early shareholders from equity dilution?
Easier said than done, it’s a strategic move. Anti-dilution provisions are your defense, entrusting early shareholders with rights to maintain their ownership slice.
However, they’re powerful cards to play. Investors might be wary, so use selectively.
What role do employee stock options play in share distribution?
ESOPs are the golden handcuffs. They attract and retain talent, granting employees a shot at ownership, usually with a vesting schedule.
It dilutes your equity pool yes, dangle the carrot wisely. Too generous, and you risk over-dilution; too stingy, and talent might just stroll by.
How can a startup’s share structure change over time?
Change is constant, from infancy to IPO runway. Each funded milestone, be it seed or Series A, can reshape the share structure.
New investors come with fresh terms, and as your board of directors evolves, so do your ownership dynamics. Agility and foresight are your co-pilots.
Conclusion
Let’s wrap this up, shall we? We’ve dissected every angle of how many shares should a startup have, trekking through the startup valuation wilderness, and wrestling with the equity dilution beast.
- Sorting the Sheets: We’ve shuffled the capitalization table cards leading to the big question – equity’s dance with value.
- Founders’ Waltz: You’ve seen share distribution tailored to each founder’s groove—a tangle of contribution versus control.
- Onward Investors!: The navigation through investor terrain, preferred stock paths, and vesting schedule trails.
Remember this, though—it’s a journey sans a one-size-fits-all map. You chart this course, penciling in figures that mirror your startup’s heart and hustle. Armed with your newfound understanding of shares, equity, and investors, you’re set to play this complex game of chess. Make your moves strategic, think several steps ahead, and position your startup for that checkmate – successful growth and eventual exit. Keep the endgame insight, and may your shares reflect your ambition accurately and strategically.
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