If you have been following the startup market, you may have noticed thatmany new companies launch their funding operations by authorizing 10 millionshares. Again and again, startups issue 10 million shares to their earlyinvestors, and that figure is consistent across many different industries.
What you may not know is that the 10 million share figure is not a mere coincidence. There are solid reasons to issue 10 million shares initially, andif you are in the startup phase you should strongly consider following the leadthat others have set.
Authorized, Issued and Outstanding
The answer to the 10 million share question is complicated, and it's best to begin the answer with an analysis of three separate but interrelatedterms. Understanding the distinction between authorized, issued and outstandingshares is a good place to start.
The number of authorized shares is a term used to describe the maximum the corporation is legally permitted to issue to its stockholders andinvestors. Issued shares, on the other hand, are the shares that have actuallybeen provided to the shareholders of the corporation.
The number of outstanding shares refers to the issued shares that are currently available for trading. Keep in mind that corporations have the rightto buy back their own shares as market conditions change, and that abilitymeans that the number of issued shares and outstanding shares can be different.
Credit Limits and Startup Shares
You can think of the number of authorized shares in terms of the creditlimit on your credit card. When you signed up for your credit card, the bankmay have given you a credit limit of $10,000. This is the equivalent of thenumber of authorized shares for the startup in question.
Think about your own credit card use and you will quickly see theimportance of distinguishing between authorized, issued and outstanding shares.When you spend $1,000 on your $10,000 credit limit card, you are only using 10percent of what you could be spending.
The same ratio is true when it comes to startups and the number ofshares they have authorized. A startup in its earliest stages may authorize theissuance of 10 million shares, a popular practice in the business community. Atthe same time they may actually issue only a small percentage of those shares,say one million, the equivalent of that low spending on a high limit creditcard.
A Thorny and Avoidable Problem
When a startup chooses to issue too few share, they face a difficultdilemma, one that can require them to amend their corporate charters. If, forinstance, the startup authorizes only 5 million shares and needs to issueadditional shares later, they will need to change the rules of the corporation,a lengthy and expensive undertaking.
By starting with 10 million shares instead, the startup in question hasa great deal more freedom. The firm has plenty of room to issue additionalshares as new investors and stockholders come onboard, giving them the roomthey need to expand their operations, invest in future production capacity,hire more employees and ultimately build a better and more successful company.
There are additional hurdles in changing the corporate charter,especially for startups that began attracting investors by authorizing too fewshares. Further complicating the matter is the fact that there are currentshareholders to consider, investors who may not be so eager to authorizeadditional shares once they are already trading in the marketplace.
Current shareholders know that when the company issues additionalshares, the shares they currently own are likely to go down in value. This isobviously not a scenario investors want, and they may be highly unlikely toallow these kinds of changes to take place.
The Accepted Standard
By now it should be obvious why so many startups have chosen to begintheir corporate lives by authorizing 10 million shares. It can be difficult toknow at the beginning how many shares will be necessary, and beginning with ahigh number makes a lot of sense and avoids a great deal of uncertainty downthe line.
When the startup authorizes 10 million shares, it can avoid the need toincrease the number of shares down the line. The fact that so many startupsinclude company stock as part of their compensation packages is another reasonis one more reason so many companies have already followed this path.
When you authorize 10 million shares for your startup, you make it veryunlikely that you will ever need to offer an investor a fraction of a share, apractice that those providing the capital will surely not like or agree to.Think about the startup that authorizes 10 million shares and follows that withan initial issuance of 10,000 shares. Those figures mean that the company in questionhas now issued just 0.1 percent of the total shares they can issue, giving themplenty of room to grow in the future.
A Lower Price = A MoreAttractive Investment
In addition to the other benefits, authorizing 10 million shares canmean that those individual shares begin trading at a lower price, a practicethat has been proven to attract more attention among the investor community.
With 10 million shares authorized, the share price will be lower, givingthe stock as well as the company more room to grow and thrive. In spite of therealities and vagaries of the market, the fact remains that investors simplyfeel better about buying stock at a lower price, and that is one more reasonfor startups to begin with a high authorization of 10 million shares.
From keeping early investors happy and compensation employees fairly tobringing in additional capital for their firms, there are plenty of reasons whyso many startups are authorizing 10 million shares. If you are running astartup of your own, you might want to keep that 10 million figure in mind. Theadvantages are clear, and this is one case where past experience should indeedguide future behavior.