One decision to make when incorporating is “How many shares do you want to authorize?” A common misconception is that the number of authorized shares (which appears in the certificate or articles of incorporation) is necessarily equal to the total number of shares (e.g., to the founders). However, there is a difference between “authorized” shares and “issued and outstanding” shares.
- “Authorized shares” refers to the number of shares the corporation is allowed to issue under its certificate or articles of incorporation. 10 to 15 million is a commonly used range (we set 10 million as default for the Cooley GO Docs Incorporation Package).
- “Issued and outstanding shares” refers to the number of shares that have been issued and are outstanding at a given time. This number cannot be greater than the number of authorized shares. Practices vary, but we typically issue between 5 and 10 million shares to the initial capitalization table (i.e., founding team and stock option pool).
Why, then, do we authorize more shares than we issue? In addition to needing to reserve shares for issuance under your stock option plan, the reason is efficiency and practicality. If you issue all your authorized shares but then need to grant more shares, you would need to authorize more shares. This requires a board and stockholder vote, and then a document to be filed in Delaware or the state of your incorporation. This costs money (legal fees and filing fees). If you have excess authorized shares, you can issue those with much less effort, typically just approval of the board of directors.
You may also wonder why we use such large numbers. This is very common in the technology industry. In other industries, you often see corporations use much lower numbers, like 1,000 shares. But someone getting a 1% grant would only get 10 shares! It’s just optics of course, but we would rather grant someone 50,000 shares. Both represent 1%, but 50,000 shares feels better to the recipient. It also has the impact of making the per-share price lower.
Note that the number of shares can have an impact on your Delaware state taxes (see So You Owe Thousands of Dollars in Delaware Franchise Tax?). But in the early days, your tax likely will remain very low. So we suggest you follow this common practice when getting things set up.
P.S. To learn more about “issued and outstanding” shares vs. “fully diluted” shares, check out my other article Option Grants: Fully Diluted or Issued and Outstanding?