Whether you are the investor or the business owner of a startup, understanding what you are working with will help you make informed decisions. Informed decisions help you structure your business and to be mindful of funding and future stock options – because these things lend themselves to future financial stability. Understanding terminology related to company stocks is all part of this process.
Stock terminology, however, can be confusing, and three shares often misunderstood are:
- authorized shares
- outstanding shares, and
- issued shares.
Understanding these terms will also help you understand when they should be employed.
Authorized shares, also called authorized stock or authorized capital stock, refer to the number of shares a business is legally permitted to issue. This number is typically established at the start of the business via the articles of incorporation. The number of authorized shares could range from 1 share to 15 million shares or more.
The number of authorized shares is a strategic one. You need to make sure from the start of your business that you allot enough shares to account for future plans and growth. At a minimum, a corporation must have one shareholder and one share of stock. There is, however, no limit to how many authorized shares a corporation can issue.
It all depends on the company, the industry (for example, tech companies usually have stocks in the millions) expected growth, your plans for the business, and more. If you do not set the right number from the start and need to increase the amount of authorized shares, you can do so, but shareholders will have to approve it during a formal meeting. Then, if approved, an amendment will have to be filed with the relevant state – and that costs money and time.
Outstanding (also known as Issued) Shares
Outstanding shares are shares that have been issued to investors, officers, and insiders of the company or to the public and, as the definition indicates, are also called issued shares. Outstanding shares, in effect, represent actual ownership of the business – which can change from time to time.
There will always be outstanding shares equivalent to or less than the authorized number of shares. It's good to keep some authorized shares aside so you have available shares to grant later. Events that will increase the number of issued shares are events like:
- private placements
- initial public offering
- secondary offering
- stock payment
- use of warrant or option.
Treasury shares (or treasury stock) are the shares you – as the issuing company – buy back. The number of outstanding shares declines when the business buys back its own shares. Treasury stock can be resold at a later time or cancelled.
Buybacks usually occur when a business:
- wants to prop up the price of their shares;
- needs to distribute cash to shareholders (rather than giving money to shareholders via dividends); or
- wants to eliminate the holdings of a small investor.
Treasury stocks do not pay any dividends and holders do not have voting rights.
The Key Takeaway
Stocks are an important part of a startup's growth – or any company's growth for that matter. Understanding their basic meaning, purpose, and use will help you strategically propel your company into the future while maintaining a solid financial standing in the present.