As almost everyone knows, companies are owned by stockholders and that ownership is represented by shares of stock. However, legal terminology used to describe stock ownership, and how to determine and set up ownership, can be confusing both to new and experienced founders and investors alike.
For this blog, we will look at the difference between “authorized” and “outstanding” shares.
The number of shares “Authorized” is the total number of shares of each type that a company could potentially issue. This number is written into a company’s Certificate of Incorporation, publicly filed and highly visible. As a result, it usually gets far more attention than it deserves. In most circumstances, you should ignore this number because in practice a company will rarely issue the full number and the number has absolutely no relationship to ownership. Over the years, 10 million shares has become a typical, albeit arbitrary, amount of authorized shares assigned to a company at its formation. That number is then increased as needed throughout the company’s life to make sure that a company will never exceed it.
Unfortunately, both at the founding stage and thereafter it’s easy to see the number of authorized shares in the Certificate of Incorporation and assume that is the number of total shares that determines ownership. In reality, ownership is determined by the number of shares that are outstanding, not the number of shares authorized.
The number of shares that are “Outstanding” is the total number of shares that have been actually issued by a company to stockholders and not later repurchased. Only outstanding shares vote, receive dividends or get paid out when the company is sold. Regardless whether there are 10 million or 1 million shares authorized, if a company has only issued 10 shares and a stockholder owns 6 of those shares, they own 60% of the outstanding shares and therefore 60% of the company.
So how do you decide how many shares to issue? Depending on the number of stockholders, we typically find that companies start with somewhere between 1 and 5 million shares to issue as “outstanding” shares for the initial incorporation. That number creates a good foundation allowing a company to issue a wide range of share amounts while giving the smallest recipients something that still feels meaningful (i.e., 20,000 shares rather than 200).
In future blog posts on cap table fundamentals we will discuss the different ways that stock can be issued, how they can be paid for, and how to account for promises to issue stock in the future.
Inceptiv Law
Inceptiv Law was established to support and assist investor-backed, high-growth companies. We have an extensive background with vc-backed tech and life sciences startups—including work inside law firms and practical in-house experience. Our passion and skill lie in navigating the unique challenges that companies face in these competitive industries. To schedule your consultation, contact Inceptiv Law.
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