I might do a few of these posts about share terminology in the corporate structure. Today I’m talking about authorized, issued, and outstanding shares.
There’s three states a share can be in within the corporate structure: authorized (sometimes called “available”), “issued”, and “outstanding”.
First Up for Share Terminology: “Authorized” Shares When Setting Up the Corporation
Initially, when a corporation is initially set up/registered with the SOS, the incorporator (the guy who does the paperwork) states how many shares there will be, total, for that corporation. They haven’t been given to a shareholder yet, they’re just available to give out. It’s a finite number set for a variety of reasons. This is where foresight in starting your business works. The founders need to know what kind of potential future shareholders there will be, and how many of them. For a one, two or even four person company with no investor plans, this number isn’t really important.
It could be 10, 100, 500. Generally, I like to make the division of shares easy so I pick easy to divide numbers. I play with words for a living, not numbers.
Sort of like having 100 widgets in your storeroom. That’s all you have to hand out. That’s “authorized” shares. You don’t have to sell the widgets; but they are there if you need to, and that’s all you have.
However, for a company looking for future investment, you should anticipate and provide for odd-number issues of shares. This way, if an investor wants 15% of a company with multiple shareholders, an even-number of shares can be issued to them. For example, it’s just cleaner to issue, say, “19,733” shares than it is to make it a fraction of ten or one-hundred available shares to issue like “19.733”.
The raw numbers actually don’t matter that much; what investors look for is the percentage of ownership. But like I said, let’s make the math easy.
That’s “authorized”. The company can hand out that many shares, no more, but it can hand out fewer and retain the rest for future issuance.
“Issued” Shares When It’s Time to Plan for Investors
Share terminology becomes important when looking for investors. Let’s say a company wants to sell half of the authorized shares to investors. At that point, the Board of Directors will designate half of the authorized shares to be available for those investors. Those shares are considered “issued”. Simple version, and I often skip this step with my smaller clients.
The shares to be sold are pulled from the company treasury and put out for sale, like pulling stock out of a storeroom and putting it on the shelves, leaving the rest of the stock on the shelf.
By doing this, investors can calculate what percentage of the company they will own after purchasing those shares, assuming all shares are sold during an issue. They will own x divided by the number of shares sold/to be sold in the financing round (and all other outstanding shares – next section).
“Outstanding” Shares When People Possess Them
Once a share is handed to a person for whatever reason (e.g. purchase, stock award), that person becomes a shareholder. Literally, in the old days, they held the share, as in possessed it. The old AT&T share certificates your grandma had. Those shares become “outstanding” because they are no longer possessed by the company. When that happens, the amount of “authorized” shares and “issued” shares remain the same, but the available shares to sell diminishes by that amount. Pull 50 of those widgets from the stock room; put them on the shelf for sale; sell 10 of those 50 widgets, the company is left with the balance for sale. That’s 100 authorized, 50 issued, and 10 outstanding.
The total number of shares handed out to people this way is called “issued and outstanding” shares.
As a side note, “issued” shares that are not yet handed to someone are often, but not always, accounted for, just depending on who is counting and why. Another blog post on that.
Why Do We Do This?
By law, the maximum shares a company can hand out is the amount authorized initially when registering with the SOS; or if the company votes to authorize more shares to be available for issue. This way an investor who buys 25 shares in a company with 500 shares “authorized” will know that the very least his shares will be worth is 25/500, or 5% of the value of the business, if all the shares are outstanding. No more shares can be issued above that 500 absent a vote.
The main reason for this is dilution: nobody would invest a substantial amount in a company if the Directors could just authorize and sell a gazillion more shares, thus decreasing the value of the investor’s shares.
Similarly, an investor who owns 25 shares where there are 100 shares “issued and outstanding” owns 25% of the issued shares. Do you see how there are different calculations to be made here for investors?
Conclusion on Share Terminology
Once you understand this basic share terminology in the corporate structure, if you’re an entrepreneur setting up a business you can plan for future investors to join you. If you’re an investor, you can see what ownership you will have in the company.
Contact me for help setting up and operating the legal aspects of your business. In western North Carolina, Asheville, Waynesville, Hendersonville at (312) 671-6453.
Email me at: palermo@palermolaw.com.
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