You must be prepared to deal with several tasks to launch a startup successfully. These include creating a new idea and building a product based on it. Later, you’ll start hiring employees and looking for potential investors.
All this you could deal with. But then comes the question you’ve been dreading for a long time: How many shares should a startup have?
It’s no wonder, since answering this question requires knowledge. Luckily, we have this knowledge. In this article, we’re going to teach you all you need to know about startup shares.
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 about how many shares should a startup have
How many shares should a startup have at the beginning?
Startups can initially issue 10 million or fewer shares to founders and investors. The company’s needs, goals, and capital raise will determine the share count.
What is the typical number of shares a startup issue to its founders?
Depending on size, industry, and funding needs, startups issue founders different numbers of shares. However, founders often receive 10–20% of the shares.
How many shares should be reserved for future employees?
Startups should reserve 10-20% of their shares for future employees. Talented employees are attracted to the company because they can receive equity and benefit from its success.
How many shares should be reserved for future investors?
Future investors’ shares will depend on the company’s funding needs and valuation. Startups usually issue new shares in subsequent funding rounds, diluting shareholder ownership. Avoid diluting existing shareholders or giving too much control to new investors.
What is the ideal number of shares for a startup’s initial public offering (IPO)?
Startups’ IPO share counts depend on valuation and funding needs. An IPO typically issues 10–20% of a company’s shares. Market demand and company goals will determine the share count.
How do you determine the price per share for a startup’s initial funding round?
A startup’s initial funding round share price depends on its valuation, growth potential, and capital raised. An external valuation firm usually sets the company’s valuation and share price.
What is the dilution effect of issuing new shares in subsequent funding rounds?
New shares in subsequent funding rounds can dilute existing shareholders’ ownership. If a company with 10 million shares issues 2 million new shares in a funding round, existing shareholders’ ownership percentage drops from 100% to 80%.
How do you balance the need for funding with the need to maintain control of the company?
Startups must balance funding and company control. Strategically issuing new shares and setting investor terms can achieve this. Shareholder agreements and voting rights help founders retain control.
What is the role of stock options in determining the number of shares a startup should have?
Stock options can attract and retain startup employees. Startups should issue stock options to determine their share count. Startups reserve 5-10% of their shares for stock options.
How do you calculate the value of a startup’s shares in a funding round or acquisition?
Startup shares are valued by external valuation firms or investment banks. The valuation will consider the company’s financials, growth potential, and market conditions. Negotiations determine share value in a funding round or acquisition.
How many shares should a startup have? – Final Thoughts
When it comes to building your own startup, you must settle on a definite number of shares. A good resolution of this issue helps you raise funds from investments and establish solid employee stock options.
While experts recommend starting with 10 million shares, there are no rules for how many authorized unissued shares you can keep. As a rule of thumb, you should always have enough authorized shares you can offer to investors. You should also have enough in reserve to use as employee incentives.
While you can always authorize more later, doing so costs time and money. And in a startup, you can’t afford to waste either.
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