Startups Stack Exchange Archive

How to allocate shares?

posted by: Omid1989 on 2016-03-09
tagged: finance, stock
score: 5

We are 4 friends and have newly founded a private tech company, worked hard on its technology details and focused mainly on design and production. Now we want to decide about some financial things. We have nearly spent $ 30,000 , and there’s $ 10,000 remained in our bank account. (We have used our life savings and family borrowings mostly.)

Our company is limited, not public. So we are not currently in any stock market.

So here are my questions:

We had initially allocated percentages to each founder, say e.g. 25% for each of 4 founders. But recently we have decided to allocate shares instead. Because the shares are unlimited and can increase. Is this way of thinking correct? What are the pros and cons of each?
If we decide to allocate shares or stocks to each founder, how can we determine the initial number of shares, their values and their dividends?
We want to hire some other people (mostly from close friends) to work for our company. But we cannot afford to pay salaries for them at the moment. So we want to offer them some shares. How can we determine the number or percentage of their shares?
Let’s say we successfully allocated e.g. 1000 shares among 10 people (including founders and staff). Now how does the process of creating new shares work? Let’s say, after 2 months, one person wants to buy some of our shares. How do we create new shares? Can we create and sell unlimited number of shares?
Can the company declare that the number of shares cannot increase for the next 6 months?
Let’s say we allocated 1000 shares of $1 value each. Now what? Do we have to pay dividends to shareholders? Or can we give them more shares instead of dividends?
Can a shareholder say “I don’t want these shares anymore. Give my money back.” !!? And if yes, what do we have to do? Do have to pay him/her the value of his/her shares in cash? And if yes, what happens to those shares? Do we have to delete them?
Let’s imagine we are working on 2 different projects at the company. Can we split the type of their shares? Can we say this share A belongs to the profits of project A, and share B to project B? Or do we have to found another company for project B to do so!?

Sorry for asking silly and weird question. I’m e newbie to financial rules.

Thanks for your time and help.

Answer 8691

posted by: Marcus D on 2016-03-09
score: 4

Good questions here. I’ll speak from the UK point of view and someone from the US can add nuances for the local tax laws.

You will issue a number of shares in a company; I think our company has 10,000. These are the allocated to individuals who are then shareholders; we have about 400 shares allocated. Shares that are not allocated are not owned by anyone, but are unallocated in their ownership.

I think it is prudent to have a share (not sure if ‘stock’ and ‘share’ are interchangeable, ‘share’ is the normal term in the UK) ownership to describe the percentage of the company owned. This is especially important when you are considering allowing more people to have a shareholding.

I would go for larger numbers of shares allocated rather than smaller numbers of shares, as then it is easier to allow small stakes to be sold/given. e.g. If each of the four founders had 1 share each, then you can only give one share, so you are massively diluting the four founders’ shareholdings. Better is 1,000 shares each, then you can choose to give a new minority shareholder just 10 shares, or someone you want to engage more, 100 shares.

Make sure you have a shareholders agreement signed by all shareholders.

I would (if your local laws allow for it) create different classes of share. e.g. Class A shares are only owned by the founders and are voting shares, Class B shares are non voting shares, but are equal in all other respects. This stops a number of small shareholders having the ‘casting vote’ in a shareholders meeting.

With regard to your question ‘How can we determine the number or percentage of their shares?’, This depends on what proportion of the future company you want to give away. Build some excel models on various ‘what if’ situations. Include different amounts of dividends in these calculations.

With regard to your question ‘Can we create and sell unlimited number of shares?’, you can allocate any number of issued shares, so it will be up to whatever you have issued. Im certain there is a process for issuing more shares, but I can’t comment.

The company (shareholders with a vote) can declare that there will be no new shares allocated in a fixed period.

Regarding dividends, they are declared on profits. As a company you can choose to invest profits back into the company or declare some of the profits as a dividend.

There will be a nominal value assigned to shares and also a ‘market’ value, if shares are gifted there may be some personal tax liability to the individual receiving them. The ‘market’ value of the shares can be derived by a number of means, which will give different results. Here are a few ways. I’m no expert in this area, this is just from my understanding. (I would expect there is a good answer in SE somewhere, but couldn’t find it with a cursory check)

Use ‘net present value’. Trouble is that ignores any IP you have and good will.
Value the business on the basis of past sales. Use a multiplier for repeat business (between 2 and 10) and multiplier of 1 for one off consulting business. e.g. If you have some long term contracts worth £100,00/year with a good profit margin on them it might be deemed to have a multiplier of 5, then additionally you might do an extra £200,000 of consulting work in a year, so your total valuation is £700,000.
What assets do you have? Depending on the type of business this can have an effect?
Discounted cash flow - what dividends are you expecting to declare for the next 10-15 years?
Are you a online product based business, this may induce your multiplier to be higher.

Regarding ‘Can a shareholder say “I don’t want these shares anymore. Give my money back.”?’ … that is tricky. That is one reason to have a shareholders agreement so that everyone knows where they stand and knows the process by which they can sell their shares. Often shares will be sold back and split among the existing founders, if they don’t want them, then the company will purchase them back. you then get into the issue of what the shares are ‘worth’. That’s really tricky and I’m going to sidestep that (maybe ask that question to SE separately).

Regarding your last question ‘Let’s imagine we are working on 2 different projects at the company.’, in the UK having different classes of shares for different people/projects so they can be paid differently is viewed poorly by the HMRC, I would ask about the bigger picture, why is it important to do that? If it is necessary, then perhaps a second company with a different shareholding split. That gets a big complicated to manage, especially if you have an increasing number of projects. There will be company ‘control’ issues that need to be considered to make it tax efficient. This is something you should get legal and tax advice over - note I say both legal and tax, since they often come at things from different perspectives.

Best of luck!

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