In forming your corporation, understanding the share structure you might want to use is very important. The goals and desires you have for your company will play a role in the share structure of you company. If you intend for your company to always be only your company with you as the only shareholder, then the authorized shares and issued shares might not be so important.
However, if you believe that you might want to raise investment capital in the future, perhaps even take the company public, then how you structure your company in the initial filing of your articles of incorporation might be very important.
You want to have a higher number of authorized shares, for example 100,000,000 shares, and you might want to have Preferred Shares authorized.
Below are brief descriptions of Authorized Shares, Par Value and Preferred Shares. None of the information below is intended to be legal advice and is only for informational purposes.
Authorized Shares - You are preparing to file your Articles of Incorporation (see “ARTICLES OF INCORPORATION”) with the Secretary of State of the state in which you have chosen to be domiciled. You now must makes several decisions such as officers, number of authorized common shares, par value of shares (see “PAR VALUE”) do you want preferred shares (see “PREFERRED SHARES”) who will be your Resident Agent and perhaps some others.
For the small company that does not see itself as raising money from outside sources privately or going public in the future, the number of common stock may not be so important. If there is a possibility of the company raising money in the future, either through a private placement or public offering, the authorized shares can be very important, both common shares and preferred shares.
There are many other considerations that might enter into the decision such as stock options to employees or others.
It is important to understand that authorized shares is different than issued shares.
Issued shares is those shares that are issued to the founders and perhaps the initial investors or other that might participate in the company.
Authorized shares of a new company might be anywhere from 10,000 to hundreds of millions of shares. Some attorneys might prefer the authorized common shares to be 10,000,000, while other might desire the authorized common to be 100,000,000 shares. Par value for the common shares might be $0.001 or $0.0001.
Even if the company is authorized 100,000,000 common shares, perhaps only 1,000,000 or 5,000,000 might be issued to the founder. Again, how many shares are originally issued to the founders becomes very critical in the future actions of the company such as raising money. The founders may always want to remain in control of the company, which means retaining 51%.
Once the corporation is formed, and a Board of Directors is appointed, the board of directors can then authorized the issuance of common stock to the founders. (There may be on 1 board member who is the founder). Consideration for the shares issued to the founders may be cash, (perhaps at par value), for assignment of assets or intellectual property, or even for cost incurred in the startup of the company.
Any part of the authorized stock that is not issued remains “authorized but unissued” shares.
These are now shares that the corporation will have at its disposal and can issue or sell in the future or issue for whatever reason. It is always best to have a sufficient number of shares available to be able to do whatever the company might want to do in the future.
An example of cash payment might be that if there are 3 founders, and each paid in $1,000 to get the company started, and the par value of the company is $0.001, each person could then take 1,000,000 shares for their $1,000 investment. The amount of share that the founders take, again should be based on a number of decisions, especially what the company see for itself in the future.
The founders of the company should very carefully consider all of these decisions, along with the corporate attorney. Always attempt to consider what the future might bring for the company. A wrong calculation can be very costly in the future.
Par Value - The Par Value of a stock is the value of a share of stock (both common and preferred) stated in the corporate charter 9(Articles of Incorporation). Par Value is simply arbitrarily chosen by the incorporators (and their legal counsel) at the time of filing the article of incorporation with the Secretary of State. Par value is usually “no par value”, $0.001 or $0.0001. The par value normally has little bearing on anything else involving the company. It usually means that the company can never sell shares, either privately or on the public market for less than the Par Value.
Par Value in finance and accounting means stated value or face value. From this come the expressions at par (meaning at the par value) over par (meaning over the par value) and under par (meaning under the par value.
The Par Value has bookkeeping purposes also. It allows the company to put to put a value for the stock on the company’s financial statement.
Even in jurisdictions that permit the issue of stock with no par value, the par value of a stock may affect its tax treatment. For example, Delaware permits the issue of stock either with or without a par value, but by choosing to assign a par value, a corporation may significantly reduce its franchise tax liability.
Par value may also be used for setting the minimum legal capital that the corporation must have after paying any dividends or buying back its stock.
It may be legal for a corporation to issue "watered" shares below par value. However, the purchasers of "watered" shares incur an accounting liability to the corporation for the difference between the par value and the price they paid. Today, in many jurisdictions, par values are no longer required for common stocks.
Preferred Stock - “Preferred stock” is stock that can be authorized by a corporation in addition to the common stock that is authorized. Preferred stock is authorized when a corporation files the corporation. A number of preferred shares is atuhorize3d. For example, a corporation may authorize 100,000,000 shares of common stock and 10,000,000 shares of preferred stock.
Preferred Stock is usually issued for special situations, for example to certain investors.
Preferred stock is usually senior to the common stock in a number of ways. Preferred stock may have certain voting rights, for example 10 votes for every 1 of common. The preferred stock may have certain conversion rights such as convertible at the rate of 5 shares of common for each share of preferred stock owned by the shareholder. Preferred stock is almost always senior to the common stock in the payment of dividends and in case of a liquidation of assets of the company. There can be several classes of preferred stock, each having different preferences.
The articles of corporation may spell out the preferences of the preferred stock, however, the board of directors of the company almost always has the authority to issue preferred stock as well as set any and all preferences thereof.
In filing corporation papers with the Secretary of State of any state, it important to make the decision whether preferred stock should be authorized. Remember that even though preferred shares are authorized, they may never be issued, and, if issued, the board of directors can set any and all preferences.
STOCK WARRANTS AND STOCK OPTIONS - The differences - A “Stock Option” is a contract between two people that gives the holder the right to purchase or sell outstanding stocks at a specific price and at a specific date. However, the holder of the Stock Option is not obligated to purchase the stock.
Stock Options usually come into play when it is believed that the price of a stock will go up or down, (depending on the Option type).
A “Stock Warrant” is similar to a Stock Option, giving the holder the right to purchase stock at a specific price and at a specific date.
However, there are two major differences between an Option and a Warrant.
1. A stock warrant is issued directly by the Company itself.
2. Under a Stock Warrant, new shares will be issued by the company for the Warrants
This means that for Warrants issued by the Company, it is dilution of the shares of the company. Companies usually issue Stock Warrants to raise money.
Stock Warrants are an excellent way for investors to own shares of a company because a warrant usually is offered at a price lower than what the company and investor expect the value of the stock to be in the future. A Stock Warrant can be for many years while a Stock Option is usually for two or three years.
When a Stock Option is exercised, the shares usually are received or given by one investor to another, and any funds paid or received are between the two individuals.
When a Stock Warrant is exercised, the shares that fulfill the obligation go directly to the company and not to an individual.
When considering the use of Stock Warrants or Stock Options, the company should seek the advice of their legal counsel.