How many shares should be authorized in the certificate of incorporation?

Eric Save / November, 2017

Description

Eric Save, Partner at K&L Gates LLP explains the difference between authorized and issued shares and how much authorized shares you should have when setting up your incorporation.

Video Transcript

How many shares should be authorized in the certificate of incorporation?

Typically what I advise clients to do is to provide plenty of room for authorized shares, and so typically that will be a fairly high number. The sort of the standard is 10 million shares as authorized shares in the certificate of incorporation. One thing to understand is that authorized shares are not the same as issued shares, so just because it says in your certificate of incorporation that you have authorised capital of 10,000 shares, I’m sorry, 10 million shares, that doesn’t mean that you’ve already issued those shares and you have shareholders holding 10 million shares.

Typically, when you start a company, you will only issue a certain portion of those 10 million shares to the founders of the company, and when I say that you need to leave some room, what you need to leave room for, is a stock option plan and a potential future financing where, an outside investor comes into the company and is going to invest in the company. Often investors will come in and they will want preferred shares so that one that has special rights and shares that can be converted into common stock. Typically, the conversion rate will be one-to-one at least at first and so you’ve got to kind of plan and figure how many shares do we need for the stock option plan that we want to create, how many shares do we think we need to reserve for our first round of financing, and it’s just better to allow yourself a little bit more room so that you don’t have to go back and amend the certificate of incorporation later because it’s a bit of a hassle to amend a certificate of incorporation.

You have to get a new board and shareholder consense and then you have to make a filing with the state of Delaware or whatever state you’re incorporated in to make that amendment. The only thing you want to be careful with is being aware if you’re in Delaware with how the Delaware franchise tax works. Because they’re sort of two methods in which they can calculate the franchise tax and if you don’t do it the right way if you have a large amount of authorized stock, you could get a pretty high franchise tax bill from the state of Delaware.

But fortunately there’s another method of calculating the franchise tax, that isn’t just basically based on the number of the authorised shares, it’s based on the value of your growth assets and the number of issued shares, and typically for a startup company that doesn’t have much in terms of assets, just getting started, they can kind of control the amount of that franchise tax won’t be a significant amount going forward, but just something to keep in mind in terms of authorized shares. Typically, the tried-and-true method is to provide plenty of room for your stock option plan and for any other issues of stock that you plan to do in your early years.

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QUICK INFO

  • Eric Save, K&L Gates LLP
  • November, 2017
  • 3:23
  • Legal

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