Authorized or Outstanding Stock: What Percentage Does a Startup Founder Own?

Here are two questions that I get often.  Should the founders of a startup company divvy up all of the stock?  If not, how do I calculate ownership percentage?  In order to answer these, we have to review the difference between authorized shares and outstanding shares. At formation, a company must state the number of total shares that are authorized under its charter document (the name of the charter will vary by state but will be called Articles of Organization, Certificate of Formation, or something similar).  This is the "bank account" of stock for the company and represents the maximum number of shares that stockholders can own.  Once you give out this stock, you need to amend the charter before you can issue any more. However, the authorized shares do not represent ownership in the company (see below).

The authorized number is different from the issued stock.  The issued (or "outstanding") shares have actually been given to stockholders.

The ownership percentage of a company is calculated entirely by the issued shares.  Say, for example, your company authorized 10,000,000 shares and issued 1,000,000 shares to each of two founders (a total of 2,000,000 outstanding shares).  That means that the two founders each own half of the outstanding shares or 50% of the company, and there are still 8,000,000 shares to issue.

If the company then issues 500,000 shares to third founder, then the ownership percentages change based on the new outstanding number (2,500,000).  Therefore each 1,000,000 to the first two founders now represents 40% of the company and the third founder now owns 20%.

Generally, a company wants the number of issued shares to be fewer than the number of authorized shares because a company will want to leave some shares in the "bank account" to issue at a later time without having to update its charter.  However, the number of authorized shares and the number of issued shares is arbitrary; in the above examples you could cut all of the numbers in half or by a third and the percentages would work out the same.

This gets a bit more complicated when you add in stock options, which are contracts given to holders for the right in the future to buy shares at a certain price.  Even though the stock option shares are not issued until the option is exercised, the company still needs to reserve that number of shares so it doesn't go over the total authorized number.  So before the options are exercised, the actual ownership percentages stay the same (because the shares have yet not been issued).  But the company may then refer to its "fully diluted" ownership, which means the ownership percentages as they would be adjusted assuming that all of the options get exercised.