Understanding authorized shares is important, because if you know what authorized shares are then you may be able to save your startup thousands of dollars in taxes.
Authorized shares are determined by your company’s articles of incorporation (a document that your law firm will work on) and they signify the maximum number of shares your business is legally allowed to issue. This number acts as a boundary line, which ensures your company’s capital structure stays intact and that you don’t exceed the number of shares you’re supposed to have.
For venture-funded startups, your VC investors don’t want you secretly giving away shares to just anyone, so this boundary is there to enforce that. Your authorized shares act as legal protection, not only for your VCs, but also for you and your startup’s other founders. They make sure the company doesn’t severely mess up its capitalization table.
Authorized shares vs. shares outstanding
VC-backed startups do distinguish between authorized shares and shares outstanding. Your shares outstanding include:
- Shares that have been purchased by your investors
- Share that the founders own
- Shares in the option pool
And this knowledge directly impacts:
- Your control over the company
- How much investors own
- The company’s appeal to your investors
- The cap table
That’s why understanding your share count and your authorized and outstanding shares is so important.
How authorized shares impact Delaware taxes
The majority of VC-backed startups incorporate in Delaware as Delaware C corporations. This generates a tax bill in which you owe annual franchise taxes to Delaware – essentially for the pleasure of being a Delaware C corp.
However, there is a bit of a catch. There are two ways to calculate your Delaware franchise tax, and they’re both based on your cap table and your equity.
Authorized share method
One of the ways to calculate this total is the authorized share method – which is obviously done by using your authorized share count and this, unfortunately, can result in a much higher payment.
Let’s look at an example of the authorized share method for a Delaware C corp with 10 million shares:
- For up to 5,000 shares, the company owes $175.
- On the first 10,000 shares, a $250 tax applies.
- Each additional 10,000 shares will owe an estimated $85.
- 9,990,000 authorized shares divided by 10,000 equals 999.
- 999 X $85 = $84,915.
- Adding the original $250 brings the total franchise tax bill to $85,165.
Assumed par value method
The second way to calculate the Delaware franchise tax is using the assumed par value method. Your startup will pay approximately $400 for every $1 million in gross assets, with a minimum amount of $400, and no maximum.The IRS defines gross assets as the total assets reported on your company’s Form 1120.
Let’s look at an example of the par value method for a Delaware C corp with $100,000 in gross assets, 5 million issued shares, and 10 million authorized shares:
- To get your assumed par value, divide the gross assets by the total issued shares ($100,000 / 5,000,000 shares = $0.02. So your assumed par value is two cents a share.
- Multiply the par value by the total number of authorized shares to get the assumed par value capital ($0.02 X 10,000,000 = $200,000).
- Each $1 million of capital is taxed at $400. But the company only has $200,000 of capital.
- The total Delaware franchise tax is the minimum amount of $400, since the company has less than $1 million in capital.
That’s a really big difference! Which is why most startups should probably use the par value method, since this gives the lowest tax bill. To help you estimate your Delaware franchise tax obligation, we’ve developed a Delaware Franchise Tax Calculator on our website.
Do authorized share counts really matter?
The authorized share count is ultimately an arbitrary number - what matters more is each shareholder’s ownership percentage of the company. And we always, always recommend founders use a quality cap table management software to keep track of ownership! As long as the company authorizes enough shares to meet its fundraising, hiring, and growth needs, the exact number is not critical. Founders should work with their legal counsel to determine an appropriate number of shares to authorize given their company’s specific circumstances and plans.
Consult an expert in startup taxes
So if you see that you have a huge Delaware franchise tax, it’s probably because somebody’s using the authorized share method and that’s not the right method for most startups. Instead, we highly recommend you use our calculator and consult with a CPA who understands how to work with startups.
If you have any other questions on authorized shares, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!
