Authorized shares represent the absolute maximum number of shares your corporation is legally permitted to issue to shareholders. You establish this number when you file your Articles of Incorporation with the state.
Think of authorized shares as the total inventory you are allowed to sell. Just because you have the inventory does not mean you have to put it all on the market at once.
This number is a ceiling. It is a legal limit that sits in your corporate charter. It remains there until you file paperwork to change it.
Many founders confuse this with the actual ownership of the company. It is important to distinguish potential stock from actual stock.
The Inventory Analogy
#To understand this concept better, imagine your company is a parking garage. The authorized shares are the total number of parking spots painted on the concrete. If you have 100 spots, you cannot park 101 cars. That is your physical limit.
However, on any given day, you might only have 20 cars parked in the garage. Those 20 cars represent your issued shares. The empty spots represent authorized but unissued shares. They are available for future use, but they do not represent current ownership or voting power.
For a startup, having empty spots is necessary. You need them for future investors, employee option pools, and advisors. If your garage is full, you cannot bring in anyone new without construction.
Authorized vs. Issued vs. Outstanding
#It is vital to separate these three terms to manage your cap table effectively.
- Authorized Shares: The total legal limit defined in your charter.
- Issued Shares: The total number of shares actually given to founders, investors, and employees. This number can never exceed the authorized amount.
- Outstanding Shares: This is usually the same as issued shares, but it excludes any stock the company has bought back (treasury stock).
When you calculate ownership percentages, you generally look at the issued and outstanding shares. You do not calculate ownership based on the authorized count. If you own 1,000 shares and there are 2,000 issued, you own 50 percent of the company. It does not matter if there are 10 million authorized shares sitting on the shelf.
Why the Number Matters
#Most startups incorporate with a high number of authorized shares. A common standard is 10 million.
Why such a large number? It comes down to math and psychology. When you start issuing stock options to early employees, giving them 10,000 shares feels more significant than giving them 10 shares, even if the percentage of ownership is identical.
Furthermore, having a large buffer allows you to issue stock easily without administrative headaches. If you authorize too few shares, you will eventually hit the ceiling.
Changing the Limit
#What happens if you run out of authorized shares? This usually happens during a large fundraising round.
You cannot simply issue more. You must amend your Articles of Incorporation. This process requires a board approval and a shareholder vote. Then you must file an amendment with the state and pay a filing fee.
While this is a standard procedure for growing companies, it involves legal fees and administrative time. It is better to start with a sufficient number to avoid doing this too early in the company lifecycle.
Founders should ask themselves how much flexibility they need before the next big funding event. Are you optimizing for low taxes now or flexibility later? These decisions impact your administrative burden as you scale.