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Corporate Shares

Issuing Shares to an Investor

Now, just because shares were issued for $1,000 a piece doesn't mean that future shares must also be issued for $1,000 each. Suppose, for example, you started your company with $5,000 and have grown over the last three years. Now your company is generating $30,000 in annual sales and profits of $3,000. The value of the company is now higher than it originally was. And with this, your need for more financing grows.

So you might issue five additional shares at $2,000 per share to an investor for $10,000. You still personally own five shares, but now there are ten total shares outstanding. You each own 5 shares. You now own 50% of the company and the new investor owns 50%. So now a couple of things should become clear.

  • Each share is getting pretty expensive. In general, expect to give up less equity for more money as your company becomes more established. This is why 'successive rounds of financing' typically benefit early founders.
  • It's difficult to issue any more shares without strongly diluting your ownership of the company. This is because of the small number of shares originally issued to you. Each new share issued corresponds to one-fifth of your initial ownership of the company.

This is one advantage to having a relatively large number of authorized shares and issuing yourself a fairly large number at the start. The larger number of shares allows the company to be divided up into more pieces. In our example, 100 shares represent 100 equal little pieces of the company. If you plan to own 100% of the company, it doesn't matter if that 100% of the company is represented by one share issued, 100 shares issued, or by 10,000 shares issued. But, if you intend to raise future capital, it makes a difference.

Suppose you never intended to give up more than 40 percent ownership in the company. One way to do this would have been to issue yourself 60 percent of the shares initially. That way even if all authorized shares were issued, you'd still own 60 percent of the company. You'd only have then had 40 percent remaining to sell to raise future financing.

Rather than thinking in terms of shares, you can start thinking in terms of percentage ownership of the company and future dilution and the number of shares available for future sale to raise more capital. You must plan ahead when deciding how many shares to authorize and how many to issue initially. You want to give yourself adequate future flexibility.

With the corporation as it now stands in our hypothetical example, you only have 50% control of the company. Let's suppose you wanted to 'regain control of the company,' and, as a corporate officer, you issued yourself five more shares for $1 each. Would that be considered fair? With 15 shares outstanding, you have reduced your investor's percentage ownership in the company from 50% to about 33%. Even though the investor's percentage of authorized shares hasn't changed, the percentage of issued shares makes all the difference.

The investor might ask, "What the heck was your justification for issuing more shares to yourself and cutting my ownership?" That would be a fair question. Could you answer it? In this case, what has been contributed to the company with the last purchase? continued

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