Our startup clients are sometimes asked by investors or government agencies to provide their number of authorized and issued shares—the difference between the two isn’t always obvious but is critical to understand.
Authorized shares are the total number of shares that a company is legally permitted to issue. This is a number that is designated in the company’s certificate of incorporation as the maximum number of shares that the company may issue.
On the other hand, issued shares (sometimes referred to as outstanding shares) are shares which have been sold to investors, founders or employees, i.e., someone owns them.
Given that authorized shares encompass the total number of shares that may be issued by a company, this number includes not just issued shares, but also shares issuable to employees based on equity awards (e.g., stock options, restricted stock, etc.) or to investors in the future based on warrants or other convertible agreements (e.g., upon conversion of a convertible note, SAFEs, etc.). Issued shares are drawn from the total pool of authorized shares and can never exceed the number of authorized shares.
You can think of the relationship between authorized and issued shares akin to marbles in jar. The authorized shares are represented by the total number of marbles in a jar. The issued shares are marbles pulled from the jar and sold to an investor or founder. Marbles may be taken out of the jar (issued), temporarily removed from the jar and kept safe (promised to employees or investors), put back into the jar (repurchased), or remain in the jar for future use. To get more marbles when you run out, you have to authorize more marbles!
The number of authorized shares and issued shares are generally subject to two investor requirements.
- Investors who invest in a company through convertible notes, warrants or other similar agreements will require a company to reserve at least enough shares to fulfill the promised equity for all such agreements.
- Investors will generally want to limit the overall number of authorized shares in excess of what is required by the above. This provides an added layer of protection for investors so that a company will not dilute the current investors without additional approvals to authorize more shares.
At this point, you may wonder what happens when a company has attempted to issue more shares than it has authorized. Make sure this doesn’t happen! If it does occur, a company has breached any agreement with those investors, employees or other parties that have been “issued” the excess shares. In addition to any conflict with these potential recipients, such over-issuances are often complex (but not impossible) to correct under state law.
Therefore, you should be careful in calculating and tracking the number of shares outstanding, and remember to include not only those issued shares (e.g., common stock and preferred stock), but also any shares that are reserved under any convertible agreements, warrants, employee equity grants, or any other promises regarding equity that have been made.
If you do find yourself in a situation where more shares have been “issued” than are authorized, there are often options to correct such errors under the relevant state law that can be worked through with legal counsel. However, these are often complex, costly to execute and should be avoided with some planning and diligence.
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