Outstanding Shares vs. Authorized Shares

Especially when dealing with option pools or understanding the proceeds to common stock from acquisitions, our accounting and advisory team has found that founders can have a lot of questions about the differences between outstanding shares and authorized shares. This guide will explain some of the differences between these two types of shares, their implications for companies and investors, and how they impact various aspects of business operations.

The core difference between outstanding shares and authorized shares

The main difference between authorized shares and outstanding shares is that authorized shares are the maximum number of shares a company can issue, while outstanding shares are the number of shares that have already been issued.

What are authorized shares?

Authorized shares represent the total number of shares a company is legally permitted to issue, as specified in its articles of incorporation. This number sets the upper limit for the company’s potential stock issuance.

Key points about authorized shares

1. Legal maximum. Authorized shares act as a ceiling for share issuance, preventing companies from diluting ownership beyond a predetermined point.
2. Flexibility for growth. Companies often authorize more shares than they initially need, providing room for future fundraising or employee compensation plans.
3. Shareholder protection. The limit on authorized shares helps protect existing shareholders from excessive dilution.
4. Adjustable with approval. The number of authorized shares can be increased through a shareholder vote, allowing for flexibility as the company grows.
5. Delaware Franchise Tax impact. Authorized share count figures into one of the methods used to calculate Delaware franchise taxes – the expensive method! See our DE Franchise Tax Calculator to learn more.

Understanding outstanding shares

Outstanding shares are the portion of authorized shares that have been issued and are currently held by shareholders, including company insiders, institutional investors, and public investors.

Important characteristics of outstanding shares

1. Actual ownership. These shares represent real ownership stakes in your startup. Your cap table should clearly reflect who owns these shares and in what quantities.
2. Market valuation. The number of outstanding shares is used to calculate your company’s valuation, a crucial metric for fundraising and financial planning.
3. Voting rights. Holders of outstanding shares typically have voting rights in corporate decisions. Your cap table should track different share classes and their associated voting rights.
4. Fluid number. The count of outstanding shares can change due to new stock issuances, buybacks, or conversions of other securities like SAFE notes. Keep your cap table updated to reflect these changes.

Comparing outstanding shares vs. authorized shares

Understanding the relationship between outstanding shares and authorized shares is crucial for grasping a company’s capital structure and potential for growth.

Key differences

The importance of authorized shares for startups

For startups, particularly those seeking venture capital, the number of authorized shares plays a crucial role in planning for future growth and fundraising rounds.

Strategic considerations

1. Future funding rounds. Having a sufficient number of authorized shares allows startups to issue new equity to investors without the need for frequent shareholder approvals.
2. Employee stock options. SAFE notes and stock option pools require available authorized shares for potential conversion or exercise.
3. Mergers and acquisitions. Extra authorized shares provide flexibility if your startup is going to buy other companies.
4. Investor confidence. A well-planned authorized share structure can signal to investors that the company has a clear vision for growth and capitalization.

Managing your cap table: Authorized shares

Authorized shares represent the total number of shares your startup is legally permitted to issue, as specified in its articles of incorporation. This number sets the upper limit for your company’s potential stock issuance.

Key points for cap table management

1. Plan for future equity rounds. You need to make sure there are enough authorized shares to accommodate any future rounds of equity financing. There are two main reasons for this.
   • Issuing new shares will dilute current shareholders.
   • Increasing the number of shares later can require board and shareholder approval, which can delay fundraising rounds.
2. Account for your stock option pool. Startups need a stock option pool for employees, advisors, and contractors. This pool comes from authorized shares, so you need enough unissued shares for future options.
3. Don’t over-authorize. You need to be careful to only issue shares that are reasonably necessary, since over-authorizing shares can erode ownership percentages and dilute ownership.
4. Remember state laws and filing requirements. Different states have specific rules about authorized shares, particularly Delaware, a common state of incorporation for startups. As we mentioned, Delaware, your franchise tax is often based on the number of authorized shares, so you need to balance flexibility with tax efficiency.
5. Keep your cap table current. Make sure you update your cap table with any changes in authorized and outstanding shares, particularly after funding rounds or employee stock grants. It’s best to use cap table management software!

Managing your cap table: Outstanding shares

Outstanding shares are the portion of authorized shares that have been issued and are currently held by shareholders, including founders, employees, and investors.

Important issues for cap table management

1. Tracking ownership percentages. The number of outstanding shares directly affects the ownership percentages of every shareholder. If new shares are issued, the ownership percentages of existing shareholders can be diluted.
2. Managing equity dilution. Founders need to understand and manage the dilutive effect of funding rounds and employee stock grants. Before each funding round, carefully consider how much dilution will occur and how it will impact existing stakeholders.
3. Determining valuation. The number of outstanding shares determines the startup’s valuation per share during fundraising rounds. For example, if the company is valued at $10 million with 1 million outstanding shares, the value per share would be $10.
4. Track convertible instruments. SAFEs or warrants are often used in early funding rounds, but can later be converted into shares and affect the number of outstanding shares, so startups need to carefully track these instruments and anticipate the dilution.
5. Adjust your cap table after every fundraising round. Typically, at each funding round, the number of outstanding shares will increase as new shares are issued to investors. This means you need to accurately record post-transaction updates in your cap table.

The importance of cap table management for startups

Effective cap table management, particularly understanding and managing authorized and outstanding shares, is crucial for startups seeking venture capital.

Strategic considerations

1. Future funding rounds. Having a sufficient number of authorized shares allows you to issue new equity to investors without the need for frequent shareholder approvals.
2. Employee stock options.: Your cap table should account for stock option pools, requiring available authorized shares for potential conversion or exercise.
3. Mergers and acquisitions. Extra authorized shares provide flexibility if your startup is planning to acquire other companies.
4. Investor confidence. A well-managed cap table with a clear authorized share structure can signal to investors that your company has a clear vision for growth and capitalization.

Summary: Best practices for cap table management

1. Regular review. Periodically assess your startup’s share structure to ensure it aligns with current needs and future goals.
2. Transparent communication. Keep shareholders informed about changes in outstanding shares and plans for authorized shares.
3. Accurate record-keeping. Maintain detailed records of all share issuances, conversions, and repurchases. Use reliable cap table management software to track these changes accurately.
4. Strategic planning. Align share structure decisions with long-term corporate strategy and growth plans.
5. Expert consultation. Work with startup venture capital finance experts to optimize your cap table structure for fundraising and growth.
6. Understand dilution. Be aware of how new share issuances, including those from option pools, can dilute existing shareholders. Model various scenarios to understand the impact of potential changes.
7. Regulatory compliance. Stay informed about SEC regulations, stock exchange rules (if applicable), and state laws that may impact your cap table management.

Impact on public market capitalization

While it doesn’t impact private, VC-backed startups in the same way, public investors also care about how companies manage their shares outstanding. A public company’s capitalization is calculated by multiplying the current stock price by the number of outstanding shares, so it really matters!

Treasury stock and its relation to outstanding shares

Treasury stock refers to shares that were once outstanding but have been repurchased by the company – this is something many public companies do with their excess cash. These shares reduce the number of outstanding shares but do not affect the number of authorized shares. The reason public companies do this is because if there are fewer outstanding shares, then each shareholder ends up owning more of the company … and this increases the company’s earnings per share (EPS), which is a important valuation metric for public companies.

Key points on treasury stock

1. Impact on outstanding shares. Repurchasing shares decreases the number of outstanding shares, potentially increasing earnings per share.
2. Financial flexibility. Treasury stock can be reissued later for acquisitions, employee compensation, or to raise capital.
3. Shareholder value. Stock buybacks can signal management’s confidence in the company’s value and potentially boost stock prices.

Regulatory considerations for authorized and outstanding shares

Companies must adhere to various regulations regarding the management and reporting of their share structure.

Key regulatory aspects

1. SEC filings. Public companies must regularly report their outstanding share counts in quarterly and annual reports.
2. Stock exchange rules. Companies listed on major exchanges must maintain minimum share counts and meet other listing requirements.
3. State laws. As previously noted, state filing requirements can affect the number of authorized shares, potentially influencing decisions on authorized share counts. And the number of authorized shares can affect a company’s taxes, like the Delaware Franchise Tax.
4. Shareholder approvals. Increasing authorized shares typically requires shareholder approval, as outlined in corporate bylaws and state laws.

Consult professional advisors

It’s important for founders to understanding the distinction between outstanding shares and authorized shares. You’ll need this knowledge for effective capital management, strategic planning, and maintaining transparency with your stakeholders.

But as you’ve probably realized from reading this, setting up a solid capital structure and managing your equity is complex, and you need to develop a clear plan before you issue stock. That’s why guidance from experienced financial advisors can be invaluable. With a clear understanding of share structures and their implications, you can make informed decisions that support your startup’s long-term success and financial health.