Taking Stock of Stock Ownership and Equity Capitalization

Entrepreneur’s Question on Stock Ownership & Equity Capitalization

“I don’t understand my stock ownership and how much of the company I own. I thought that I had 25% of the company, but my shares equal less than 10% of the authorized shares. Could you explain who owns what percentage of the company?”

Response:

When Entrepreneurs like you start new Corporations, they often are confused by the initial share ownership and equity capitalization structure of their new companies. If you’ve never been involved in starting and structuring a new corporation, you will hear new technical terms and “venture speak” that understandably may be confusing or unclear. It is important to know how these stock concepts work so that you understand the ownership of your company, which stockholders have voting control and how to structure new equity financing transactions and the issuance of additional shares.

To help guide you through this important topic of share ownership and equity capitalization structure, we summarize below some of the key stock concepts to know as you set up and manage your new corporation:

Authorized Shares:

• The Certificate of Incorporation (or Articles of Incorporation) indicates the number of Authorized Shares for your Corporation (e.g., 10,000,000 shares).
• The Authorized Shares represent the total potential number of shares that your corporation can issue over time.
• The Authorized Shares do not represent the actual ownership of your corporation at a given point in time.
• The Authorized Shares need to cover the Issued and Outstanding Shares (see below), as well as the shares that may be issued from stock options, warrants, and other convertible securities.
• Your corporation can increase the number of Authorized Shares by approving and filing an amendment to the Certificate of Incorporation (or Articles of Incorporation).

Issued and Outstanding Shares:

• The Issued and Outstanding Shares represent the actual ownership of your corporation at a given point in time.
• The number of Issued and Outstanding Shares will change over time as additional shares are issued (e.g., to investors in financing transactions or from the exercise of stock options or warrants) or canceled (e.g., due to stock repurchases by your corporation through rights of refusal or founder stock vesting arrangements).
• The stockholders that hold the Issued and Outstanding Shares have the power to vote on appropriate corporate matters.
• The holders of Issued and Outstanding Shares of Preferred Stock, as applicable, sometimes vote on an “as if converted” basis with the holders of Issued and Outstanding Shares of Common Stock, if the Certificate of Incorporation (or Articles of Incorporation) requires this type of combined stock class voting or approval for certain matters.
• The “Issued and Outstanding Shares on an As-Converted Basis” include the actual shares of Common Stock, which are then issued and outstanding (including the number of shares of Common Stock that would result from the conversion of the then outstanding shares of Preferred Stock), plus all of the shares of Common Stock that would result from the exercise of all of the then outstanding convertible securities (e.g., Stock Options and Warrants).

Fully-Diluted Shares:

• The Fully-Diluted Shares provide a complete picture of what your company’s equity capitalization or share structure would look like with the current issued and outstanding shares of capital stock, plus all of the shares that would result from the exercise of Stock Options, Warrants, and other Convertible Securities.
• The Fully-Diluted Share calculation typically includes the total number of shares in your corporation’s Stock Option Pool, even those shares that are not covered by Stock Options that already have been granted and are outstanding.
• Investors will use the Fully-Diluted Share capitalization to calculate the number of shares and per share price for their equity investments so that their investments are based on the complete equity capitalization and therefore result in more shares to them at a lower per-share price.

Your Turn:

What questions do you have about share ownership and equity capitalization? Please ask a question or share a comment and we will reply with an answer or additional blog post. Thanks in advance for your participation and your assistance to other entrepreneurs.