Stock Option Basics for Startup Founders

In the early stage start-up context, there is often so much to be dealt with -- urgently -- that many founders don’t have time to learn the basics of startup stock options from day one. This lack of knowledge can lead to legal and financial missteps that could prove costly for both companies and employees. A Priori startup lawyer can help you understand stock options basics and compliance.

Why Do Stock Options Matter for Startups?

Providing equity to investors and employees is a vital way to promote a fledgling company’s success. Stock options offer a powerful way to attract investment and talent to help the company grow, especially at the earliest stages of development. Effectively leveraging this resource -- and preventing undue dilution or loss of founder control -- requires knowledge, planning and careful execution.

Authorized Shares

The authorized shares number represents the total number of shares permitted to be issued by the company. The first time many founders consider share numbers is in relation to articles of incorporation, which establishes the number of authorized shares for a company. While post-Series A companies generally have the number of authorized shares correspond to allocated shares, generally the correlation isn’t as important for early stage start-ups.

Basic Outstanding Shares Vs. Fully Diluted Shares

The outstanding shares number represents the total number of shares that have already been issued. There are two ways to calculate a company’s outstanding shares: basic outstanding shares and fully diluted shares outstanding.

Basic outstanding shares is a simple count of the total number of shares currently held by the company's shareholders as of the date of the calculation. A more accurate way to understand the full extent of outstanding shares, however, is to calculate a company’s fully diluted shares outstanding. The fully diluted shares outstanding calculation includes all shares that would be outstanding if all possible sources of conversion, such as convertible bonds and stock options, were exercised immediately. This helps a company better understand its financial position and capitalization.

Stock Value: Share Price and Share Par Value

Of course, many factors beyond simply outstanding shares affect the value of company shares. Exactly what a company’s share price may be at any given time can fluctuate greatly based on any variety of industry, company, and market variables. Reliable profits can bring a share price up, while the exit of an important executive can bring share price down. Further complicating matters for start-ups is that because there isn’t generally a market for the privately held shares, share price is often determined either by third party valuation or by implication based on an agreed pre- or post-money valuation associated with a financing round.

It’s important to note that the market value or share price of a stock and the corresponding price that it can be traded for has little relationship to the face value assigned to the stock when it is sold. This face value—or par value, as it is more commonly called— is generally set extremely low, e.g. one cent or even at nothing at all, by the company.

FAQ

Why is it normal for shares to have virtually no par value?

Stock is commonly assigned little or no par value, because it ensures that a company never owes more on the share than they are actually worth. Essentially, the par value of a stock is a legal requirement, but it has little bearing on what the stock is actually worth most of the time.

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