How do startups typically allocate shares at formation?
At formation, startups typically authorize 10,000,000 shares of common stock in their certificates of incorporation. In this article, we'll discuss how startups can allocate those shares, as well as answer common questions about equity allocation.
Initial Equity Allocation
Here's an example of how startups often allocate 10,000,000 shares at formation:
- Founders: Approximately 8,000,000 shares distributed among the founders according to their agreed upon ownership
- Company Stock Plan: Approximately 1,000,000 shares reserved in a company stock plan for future equity awards to employees, consultants, and advisors.
- Unissued: Approximately 1,000,000 shares are left unissued and available for future use
Example:
At formation, Acme Co. has three co-founders who have agreed to equal ownership. A typical allocation of shares might be: (i) issue 2,700,000 shares to Founder Alice, (ii) issue 2,700,000 shares to Founder Bob, (iii) issue 2,700,000 shares to Founder Charlotte, (iv) adopt a company stock plan with 1,000,000 shares reserved in the company stock plan, and (v) leave 900,000 shares unissued and available for future use.
What about founder deadlocks?
"Founder deadlocks" are situations where there are two founders with an equal number of shares, and both are directors. While it is quite common for startups to have this setup in the early days, it can result in founder deadlock when the founders disagree on something or have different ideas for the future of the company — since the company's decision-making, which is determined by relative shareholding and board composition, is evenly split. To avoid this potential situation from the outset, the easiest approach is for either one founder to hold at least one more share than the other (usually the CEO) or for only one founder to be on the board. Accounting for deadlock risk upfront can end up saving the company and result in a better outcome for everyone, since deadlock can simply kill the company, notwithstanding its performance and prospects.
Frequently Asked Questions
We've compiled answers to frequently asked questions about equity allocation below. If you can't find the answer to your question, feel free to reach out to our support team. We'll do our best to help.
What about future co-founders?
A startup that knows it intends to recruit additional co-founder(s) may decide to issue fewer than 8,000,000 shares to the initial founder(s), thereby leaving enough unissued shares available to issue to the future co-founder(s).
Example:
At formation, Founder Alice is the sole founder of Acme Co; however, she intends to recruit an additional founder. A typical allocation of shares might be: (i) issue 4,000,000 shares to Founder Alice, (ii) leave 4,000,000 unissued shares for a future co-founder, and (iii) leave 2,000,000 unissued shares available for other future uses.
Why leave unissued shares?
A principal reason to leave some portion of shares initially unissued is to help a startup avoid or delay the time and expense involved with obtaining corporate approvals and making filings necessary to amend the certificate of incorporation to authorize more shares with the Delaware Secretary of State.
What are potential future uses of unissued shares?
One common use of unissued shares is to reserve additional shares to the company stock plan that is used to issue equity to employees, consultants, advisors and directors. Some startups may also use unissued shares to issue equity to an accelerator program that accepts common stock.
Why not authorize even more than 10,000,000 shares and have more unissued shares available for future use?
A startup typically issues a meaningful portion of its authorized shares because leaving a large percentage of shares unissued can affect the Delaware franchise taxes. For more information, see: How do I calculate the Delaware franchise tax?
Do unissued shares affect ownership?
Immediately following formation, a startup typically has a simple capitalization structure with no options, warrants or other securities that can be converted into stock. So long as this remains true, ownership of the startup is determined only on the basis of issued shares and, thus, unissued shares have no effect on ownership.
Example:
At formation, Acme Co. authorizes 10,000,000 shares of common stock in its certificate of incorporation and issues 4,000,000 shares to Founder Alice and 4,000,000 shares to Founder Bob. Until additional equity is issued, Founder Alice and Founder Bob each own 50% of Acme Co. (i.e., 4,000,000 shares / 8,000,000 shares).
Example:
At formation, Acme Co. authorizes 10,000,000 shares of common stock in its certificate of incorporation and issues 4,000,000 shares to Founder Alice. Until additional equity is issued, Founder Alice owns 100% of Acme Co. (i.e., 4,000,000 shares / 4,000,000 shares).