Shares and ownership

Ada owns 4,000,000 shares of Northwind. Is that a lot? You cannot tell yet. A share count means nothing until you know the total. This lesson shows how shares become percentages, and why the percentage depends on what you count.

A share is one unit of ownership in a corporation. All the shares together are the equity of the company. Your ownership percentage is your number of shares divided by the total number of shares:

Ownership = Your shares ÷ Total shares
          = 4,000,000 ÷ 8,000,000
          = 50%

Ada and Ben each hold 4,000,000 of the 8,000,000 shares of Northwind, so each owns 50%. With only 1 share for each founder, each founder still owns 50%. The number of shares does not change the value of the company. It only changes how many pieces the company is cut into.

Startups use millions of shares because later grants then have easy numbers. The law firm Cooley gives an example. In a company with 1,000 shares, a grant of 1% is only 10 shares. Cooley writes that it “would rather grant someone 50,000 shares.” In a company with 5,000,000 shares, 50,000 shares are 1%.

The value of one share is the value of the company divided by the number of shares. Ten million shares of a company with no value have no value. The lesson on price per share shows this math.

New shares dilute everyone

A company can issue new shares at any time, if its board agrees. It issues them to investors, to employees, and to advisors. Each new share makes the total larger.

Predict first

Northwind has 8,000,000 shares, and Ada holds 4,000,000. The company issues 2,000,000 new shares to an investor. What percentage of Northwind does Ada own now?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Move the slider. Look at the “Shares” column, and then at the “After” column.

Try it

Issue new shares, watch the percentages

Northwind has 8,000,000 shares. Ada holds 4,000,000 and Ben holds 4,000,000. Move the slider to issue new shares to a new investor.

New shares that Northwind issues2,000,000

Ada’s shares: 4,000,000; No change
Ada’s ownership: 40%; Was 50%
Total shares: 10,000,000; Was 8,000,000

Shares and ownership before and after the new shares
Holder	Shares	Before	After
Ada	4,000,000	50%	40%
Ben	4,000,000	50%	40%
New investor	2,000,000	—	20%
Total	10,000,000	100%	100%

Ownership after the new shares

Ada
Ben
New investor

Ada still holds 4,000,000 shares. But the total grew from 8,000,000 to 10,000,000. Thus Ada’s shares are now 40% of Northwind, not 50%. The share count did not change, but the percentage did. This decrease is dilution.

This decrease is dilution. Dilution does not take shares away from anyone. Each holder owns a smaller part of a larger total. A smaller part can be worth more, if the new shares bring in money that makes the company grow. The lesson on dollars and percent shows when dilution is a good trade.

Authorized, issued, and outstanding shares

Four words describe the shares of a company. They are layers, from the largest number to the smallest:

Authorized shares are the maximum number of shares that the company can issue. The certificate of incorporation sets this number.
Issued shares are the shares that the company gave or sold to a holder.
Outstanding shares are the issued shares minus the shares that the company bought back. The company holds those as treasury shares. In a new startup, the issued and outstanding numbers are usually the same.
Unissued shares are the authorized shares minus the issued shares. They are a reserve for an option pool and for future investors.

Stripe gives this example:

Authorized shares    10,000,000
Issued shares         8,200,000
Treasury shares         200,000
Outstanding shares    8,000,000
Unissued shares       1,800,000

The company bought back 200,000 shares, so 8,200,000 − 200,000 = 8,000,000 shares are outstanding. It did not issue 10,000,000 − 8,200,000 = 1,800,000 of its authorized shares.

To increase its authorized shares, a company must change its certificate of incorporation. This needs a vote of the board, a vote of the stockholders, and a filing with the state. Thus companies authorize more shares than they issue at the start.

Incorporation services use similar default numbers:

Clerky authorizes 10,000,000 shares. The founders get approximately 8,000,000, a stock plan gets approximately 1,000,000, and approximately 1,000,000 stay unissued.
Stripe Atlas authorizes 10,000,000 shares and keeps 15% unissued for a pool by default. Founders can set the pool from 5% to 30%. With the default, the founders get 8,500,000 shares.
Cooley says that 10 million to 15 million authorized shares are common, and its document tool uses 10 million.

The authorized number also sets the Delaware franchise tax, as the lesson on setting up the company shows.

Work it out

Ben holds 4,000,000 shares. Northwind has 10,000,000 authorized shares and 8,000,000 issued shares, and no options or SAFEs. What percentage does Ben own?

Par value

Par value is a legal minimum price for each share that the certificate of incorporation sets. Startups use a very small par value, such as $0.00001. Today, par value is important mostly for the Delaware franchise tax.

Founders buy their shares at the par value, or at the fair market value on the day of the purchase. On the first day, the two values are almost the same. Thus founder shares cost almost nothing:

Price paid = Shares × Price per share
           = 4,250,000 × $0.00001
           = $42.50

Stripe shows the same math for the two founders together: 8,500,000 × $0.00001 = $85. Founders can pay with cash. They can also pay with the work that they did before the company existed, when they assign it to the company.

Common stock and preferred stock

A company can have more than one class of stock. Startups use two:

Common stock goes to founders and employees. Employees usually get options to buy common stock.
Preferred stock goes to investors in priced rounds, such as a seed round or a Series A. Preferred stock has more rights than common stock.

The extra rights of preferred stock include a liquidation preference, conversion into common stock, protective votes, anti-dilution protection, and board seats. The liquidation preference is the easiest right to see in numbers. It lets the investor get money back first when a buyer purchases the company.

Here is an example. An investor pays $2M for preferred shares that are 20% of the company. A buyer purchases the company for $5M. The investor can take the $2M back first, or convert to common stock and take 20%. The investor takes the larger amount:

Preference = $2,000,000
Convert    = 20% × $5,000,000
           = $1,000,000
Investor   = $2,000,000, the larger amount
Common     = $5,000,000 − $2,000,000
           = $3,000,000

The lesson on liquidation preferences gives the full rules. A SAFE is different again. A SAFE is not stock. It is a contract that usually becomes preferred stock at the next priced round. The lesson what is a SAFE explains it.

What “fully diluted” means

The question “What percentage do you own?” has more than one answer. The answer depends on the total that you divide by:

Basic ownership divides by the issued and outstanding shares only.
Fully diluted ownership divides by every share that exists or can exist. The total adds the options that employees hold, the unused part of the option pool, and the shares that SAFEs and convertible notes can become. This total is the fully diluted shares count.

Investors use fully diluted numbers in a negotiation, because each of those shares can exist one day. Here is an example with the Stripe Atlas defaults. Two founders hold 4,250,000 shares each, and the board adopts a stock plan with 1,500,000 reserved shares. Basic ownership stays at 50%, because nobody holds the reserved shares yet. Fully diluted ownership is 4,250,000 ÷ 10,000,000 = 42.5%.

Now take a later Northwind. Employees hold options, the pool has shares left, and an investor bought a SAFE for $500K. The SAFE has a $10M post-money valuation cap. At that cap, the SAFE becomes $500K ÷ $10M = 5% of the company. The steps below count Ada’s fully diluted ownership.

Worked example · step 1 of 5

Ada's fully diluted ownership of Northwind

1
Start with the issued shares
Ada and Ben hold 4,000,000 shares each. On this count, Ada owns 50%.
```
Issued = 4,000,000 × 2
       = 8,000,000
Ada    = 4,000,000 ÷ 8,000,000
       = 50%
```

Now count it yourself. Tick each row that you want in the total.

Try it

What counts in the denominator?

Ownership is your shares ÷ the total. Tick each row that counts in the total, and watch Ada’s percentage.

Northwind shares, and which ones count in the total
Holder	Shares	Ownership
AdaCommon stock, issued	4,000,00050%	50%
BenCommon stock, issued	4,000,00050%	50%
EmployeesOptions, granted	500,000Not counted	Not counted
Unused option poolReserved, not granted yet	1,000,000Not counted	Not counted
SAFE investor$500K at a $10M post-money cap, as converted	500,000Not counted	Not counted
Shares counted	8,000,000	100%

Shares counted: 8,000,000; Issued shares only
Ada’s ownership: 50%; 4,000,000 ÷ 8,000,000

Ownership of the shares counted

Counted on issued shares only, Ada owns 50%. This is her basic ownership. It leaves out 2,000,000 shares that options, the pool, and the SAFE can become.

The SAFE row is an estimate. A SAFE becomes shares only at a later priced round, and the lesson on post-money cap math shows how. The lesson on reading a cap table shows these rows in a full cap table, the list of every holder and its shares.

Work it out

Founders hold 9,000,000 shares, employees hold options for 400,000 shares, and the unused pool has 600,000 shares. A founder holds 4,500,000 shares. What is that founder's fully diluted ownership?

Quiz · question 1 of 5

Test what you learned

Alice holds 4,000,000 shares. The company has 10,000,000 authorized shares and 8,000,000 issued shares, with no options or SAFEs. What percentage does Alice own?

In this lesson you will learn