By: Anjana Puri
Starting your own business can be complicated. From deciding which corporate entity to use to structuring equity in the company, each decision needs to be well-thought-out in order to ensure the success and longevity of your business. If you choose to incorporate, you may wonder how to structure ownership of the company to promote long term growth.
Corporations have two subsets of shares: authorized shares and issued shares. The authorized shares are designated in the company’s Certificate of Incorporation, and are the number of shares the Board of Directors may issue without amending the Certificate of Incorporation. By contrast, issued shares are shares that have actually been sold and are outstanding.
Many founders have a natural inclination to issue the entire number of authorized shares amongst themselves. However, this can be problematic, especially if the company plans to use equity to bring in new investors. Authorizing additional shares is not a seamless process. To do so, the company must amend its Certification of Incorporation, which requires a vote of the stockholders. It also requires making a state filing and paying associated fees. Holding authorized but unissued shares in reserve may allow you to offer equity to future investors without amending the Certificate of Incorporation.
Additionally, if you are trying to attract top talent, it may also be wise to hold a certain amount of authorized (but unissued) shares in reserve to exclusively be used as part of an employee incentive plan. Companies will generally reserve 10-30% of authorized but unissued shares for this purpose. Note that the share reserve needs to be sufficient for the company’s hiring needs until the next time that the Certificate of Incorporation is amended.
Finally, it is important to remember that when authorizing and issuing shares, your company must comply with several corporate formalities. For example, to properly issue founder shares, the company may need to follow some of these procedures:
- obtaining Board authorization (either at a meeting or by written consent) for the issuance;
- executing a stock purchase agreement (preferably with vesting) documenting the sale and issuance of the shares;
- giving consideration in some form paid for the shares;
- if the company has certificated shares, preparing and signing stock certificates to evidence ownership of the shares (but kept in escrow by the company secretary, and not distributed to the stockholder, if the shares are subject to vesting);
- complying with both federal and a state securities exemption regulations (which sometimes require a filing); and
- if the shares being issued will vest in the future, filing a 83(b).
Carefully planning how to structure ownership in your business in a way that promotes long term growth can be very beneficial. You may want to consult with an experienced business attorney to help you determine the best method to issue equity given your corporation’s hiring and capitalization needs.