Issuing Founders’ Stock: Purchase Price

Corporate Formation

33 Comments 22 September 2011

The norm for technology startups is for the founders to purchase the initial common stock at a very low price at $0.01 per share or less.

I usually sell the initial common stock at $0.001 per share. Part of the reason why I do this is because I like to issue each founder 1,000,000 shares of common stock at incorporation. By selling the shares at $0.001, this gives me a nice round total purchase price per founder of $1,000 (i.e. 1,000,000 x $0.001). At $0.01, the founders would have to pay into the new corporate bank account $10,000 each. That sure is a lot more painful. Especially considering that some Web 2.0 startups do not need more than a total of $10,000 to start their company.Even less if they already know how to set up a website and program all the back-end stuff themselves. I am currently representing some amazing Web 2.0 startups that have started with around $5,000 in the bank and are doing great.

When talking purchase price, remember that anytime securities are sold, they must be sold at fair market value or there will be certain tax consequences related to recognition of ordinary income, cheap stock, etc. The reason we can have the company sell the common stock to the founders at $0.001 per share (and reasonably argue that the fair market value is $0.001 per share) is because the company is arguably not worth anything at the time of incorporation. It is at ground zero. However, as soon as the company signs a significant contract, or starts generating income, the fair market value must be more than $0.001.

Sam Wu
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Sam Wu

Startup Attorney/ Partner at Innovation Capital Law Group
Sam is a partner with Innovation Capital Law Group and specializes in startup representation, corporate finance (i.e. angel investment and venture capital financings), mergers and acquisitions and licensing transactions.

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  • http://www.insitecreative.com J Rai

    Just stubbled upon your blog … Great article and invaluable advice for someone like me who is trying to get a startup off the ground with limited personal funds. I’ll be looking to accelerate growth shortly after launch through outside capital investment and want to ensure I have the correct structural foundation that attracts investors and ensures I have allocated the initial allocation correctly to grow the company smoothly. Quick question; I have no partners or co-founders and the company is worth little to nothing now except my time and money can I allocate myself 100% of the stock 10,000,000 shares at 0.0001 and establish the entity for $1000. Or would you advise not allocating all stock initially ? Delaware S Corp or Local(Boston, MA) filing ?

    Any advice you can offer would be greatly appreciated. Thanks again for an invaluable blog article.

    J Rai,
    Cambridge, MA

    • Sam

      Generally, I like to authorize 10,000,000 shares of common stock but only issue out a portion of that to founders leaving a good number still in the authorized pool. I usually issue about 1,000,000 to 3,000,000 shares of common stock to the founders depending on the situation. The principle to understand here is the difference between authorized shares and issued shares. Authorized shares is everything that is allowed to be issued pursuant to the Certificate of Incorporation. Issued shares is the number of shares actually sold and issued out to founders or employees. The reason I like to leave a good number in the authorized pool is to allow for issuances to future employees and consultants. This is especially important if you are boot-strapping the startup and need to pay developers and consultants with shares of common stock.

  • Inquisitor

    What are the implications if the founders of a company never actually paid for their founders’ shares (i.e no recorded cash transaction, no supporting evidence, no documented trail of payment).

    Could their ownership stake be in jeopardy?

    Is that considered securities fraud?

    And what are the remedies available to the founders? Or those available to potentially disgruntled preferred shareholders?

    • Sam

      That is an important issue because the shares are not fully-paid (a legal requirement of properly issued shares), and, yes, their ownership could be in jeopardy because they never properly paid for their shares. To remedy the situation, it would require a much more in-depth understanding of the circumstances, but there probably is way to fix the problem and put the shares back in compliance with securities laws. If a founder is determined to never have paid for their shares, those shares can be taken from them in the future upon an acquisition or financing when the due diligence is completed by legal counsel. Disgruntled preferred shareholders might be able to claim breaches of representations, warranties and violations of securities laws.

  • Stephen

    Lets assume the founders bought their shares with a nominal price lets say $0.0001 per share and the seed investment were raised using a convertible debt. Doesn’t that mean that the stock price according the accounting is still at $0.0001, even if the real market price may be lots more? And does it matter what the accounting says on the stock price?

    My concern is wheter >50% of the voting power of the company cans issue all the authorized stocks to anybody with the same nominal price, and even authorize more stocks to be issued to anybody with any price or (even lower than the earlier purchases)?

    And if so, isn’t that against the rights of any kind of option holders and minority share owners?

    • Sam

      I’m not sure what you mean by “what the accounting says,” but the general principle is that you purchase stock at the fair market value at the time of purchase. So, if you purchased your founder’s shares at $0.0001 per share, that is the fair market value at the time of incorporation. Hopefully, as your startup grows, the fair market value of your shares will increase so that an investor purchasing shares one year from the date of incorporation will then pay $1.00 per share or some other higher value. You might actually be referring to the “par value” of the shares that the accountant might have to take into consideration to determine the amount of tax owed by the corporate entity. In this case, you are right there is very little relationship between the actual fair market value and the par value. The par value is a very archaic term that has actually been disregarded in some states, such as California, where the common stock may have no par value.

      Shareholders with greater than 50% voting power will have the ability to dilute all current shareholders, unless the current shareholders have some sort of anti-dilution rights or rights of first refusal or some similar right. There are possible minority shareholder rights that could allow the shareholders to claim a breach of fiduciary duty but that would depend on the circumstances.

      Finally, your last question — whether it violates the rights of any existing option holders or shareholders really depends on the type of rights held by such security holders.

  • http://www.thegslgroupllc.com Randy Lewis

    Great stuff Sam. I have reviewed several of your posts and is very practical and valuable information. If any of your clients (or clients to be) need help with business plans or such, look me up. http://www.thegslgroupllc.com.

    Cheers

    • Sam

      Thanks Randy. I will let you know if I come across any clients that could use your services. If you are ever down in Orange County, let me know and we can meet up. Thanks.

  • mehrdad

    can the stock be priced as 0$ per share upon incorporation or the number should be larger than zero?

    • Sam

      The stock price should be something higher than zero. The idea is that the stock needs to be “fully paid” to be properly issued. Typically, the stock is sold at a nominal value at the time of incorporation. I usually set it up at $0.001 or $0.0001 per share.

  • Steve

    Hi Sam.
    My son is at school in Oregon with one more year before he returns to the San Francisco Bay Area. He and a group of students/techies are starting a company offering a Website service and he is wondering if he should form an LLC? Right now, he is the founder and majority owner (likely 90%, or so). Is the LLC the right structure for him, and if so, can he still issue or assign percentages of ownership like a stock?
    Lastly, do you have any recommendations or advice for how allocation of future equity might be established?
    Thanks.

    • Sam

      It is difficult for me to give a definitive answer on whether an LLC or a corporation is the right structure for your son’s company. However, generally, I like to structure technology startups as corporations instead of limited liability companies. A few reasons for this:

      1. Investors of technology startups are more familiar and comfortable with corporations.
      2. There is greater predictability of corporate governance for corporations.
      3. For tax reasons, most venture funds are precluded by their pension fund and other tax-exempt limited partners from investing in limited liability companies because an LLC is a pass-through tax entity.

      Regarding the allocation of future equity, it all depends on the the recipient — who they are, what do they bring to the table and their level of commitment. Think of equity allocation as the granting of a right to benefit in the future growth of the company. This analysis is often a difficult one and depends on numerous factors.

  • Andrew

    Hi my name is Andrew. I want to invest in buying founder shares/ founder stock problem is I don’t know how & where to buy them I would love some advice and some suggestion of which companies I can buy founder stock?

  • Ashlie

    Dear Sam,

    I am creating a Florida for profit corporation which will elect to be S corp. I will be the only owner, and if I am understanding things correctly the only shareholder, and director of the corporation. My mother whom is a bookkeeper of countless years will be the appointed treasurer and secretary as I will act as the President. She has agreed to basically work for free save for in the case when the company has a net profit wherein she agrees to receive as compensation of 25% of the net profit in an amount not to exceed 30,000 USD. As President, I intend to compensate myself with 50% of net profits with the payment of my mother taking priority over my own payment. I will receive no compensation as Director.

    My state requires a minimum of 1 share of stock to be authorized upon filing of the articles of incorporation with no par value set.

    My question to you is:

    How in the heck do I make all of this work?

    Do I authorize X amount of shares of stock upon the filing and have the corporation sell me those shares in their entirety as common stock?

    OR

    Do I authorize X amount of shares, purchase the controlling portion, purchase for/ or give 25% of the stock to my mother and that counts as her “payment” for services rendered and the remainder staying in a reserve of the corporation to use at a later time?

    I’m really confused with all this. I have very little money and every dollar i have i am investing into the creating of this business which will be a .com that sells items through a drop shipper and also has a members access only areas per subscription and also serves itself as short run publisher to publish books written by myself.
    I don’t even expect the company to turn a profit for the first 2 or 3 years of existence. I know I will have to keep personally putting money into the company till it gets going.

    I know that an LLC is offers similar protection as a corporation but LLC’s tend to be looked in a less favorable light as opposed to a corporation (by the outside world namely banking institutions) which is my reason for choosing to incorporate.

    Any advice or opinions you can give me would be much appreciated. I am well aware that anything you say should not be interpreted as legal or tax advice and that I should only go by the professional opinion of a profession whom I have contracted for such advice and that anything you tell me should not be construed to represent that as such.

    Sincerely,

    Ashlie M.

  • danish

    Hi Sam,

    Thanks a lot for this site and post. Do you recommend a particular state as far as incorporating a corporation is concerned? I know Delaware is popular and the reasons behind it, but what are your thoughts on this?

    Also, from a legal standpoint who owns the authorized shares when they haven’t been issued? Say there are two founders and you authorize 10M shares and the founders buy 1M each. The remaining 8M in pool are owned by who? The corporation, correct? But doesn’t that mean the only two owners of issued shares own them as well? I hope I’m clear.

    Do you do work for companies in NYC?

    Thanks!

    • Sam Wu

      You’re welcome. Generally, for technology startups I recommend Delaware. It’s a popular choice for good reason — company favorable case law, well-established corporate codes and familiarity for investors.

      For authorized but unissued shares, no one owns them. They are a pool of shares that the company is “authorized” to issue and sell. If there are 2 founders, each holding 1,000,000 shares each, then the total issued shares is 2,000,000 shares (i.e. 1,000,000 x 2). Therefore, each founder holding 1,000,000 holds 50% of the company (i.e. 1,000,000/2,000,000). The remaining 8,000,000 shares that are UNISSUED but authorized will be left for future stock issuances or for the stock option plan.

  • http://www.qtility.com Susan Jessup

    I understand how this works if the startup does not have any value when founded but what if it does? Let’s say it has a product already built and ready for market (built mainly by another company that wishes to spin it off into a separate entity and own a large percentage of the new entity)and can be reasonably valued at 3 million? Is there a way to set it up without triggering tax ramifications for the founders?

    • Sam Wu

      For any question relating to tax ramifications, I would defer to an accountant. Let me know if you need some referrals. However, I think it is important to point out that simply having a product ready for market doesn’t necessarily create a $3 million or $1 million valuation.

  • http://www.techstartuplawyer.com/ Sam Wu

    Susan — unfortunately, i would not be able to give you an opinion on a reasonable valuation of $3 million simply because a product is already built, especially if the product was built by another company.

  • http://www.techstartuplawyer.com/ Sam Wu

    You are correct, Delaware is generally the state of choice for technology startups. The case law and corporate codes are well-developed and more company-favorable than many other states. Also, investors (and their attorneys) are familiar and comfortable with Delaware corporations.

    Regarding authorized (but unissued) shares — no one owns them. They are left in a pool for future issuances or conversions. We do work with NYC companies and I would be happy to explore the possibility of working together if it is a good fit for your startup. Thanks for your questions.

  • http://www.techstartuplawyer.com/ Sam Wu

    Hi Ashlie — thanks for the comment post. You have a lot of questions that you will probably need to have a good sit-down with a good local corporate attorney. Obviously, i would defer to any attorney that you can speak to more in-depth, but at first glance, I would probably authorize a small number of shares of common stock and issue a portion of it to yourself. You don’t need to issue your mom 25% of the shares of common stock to pay her the $30,000 from future revenue. Actually, by issuing her 25% of the common stock it might actually complicate things more in the future because the shares will not be cancelled once the $30,000 is paid off. Hope that helps.

  • http://www.techstartuplawyer.com/ Sam Wu

    Hi Andrew — I don’t have any specific companies to refer to you. If you are looking to make angel investments, I suggest connecting with your local angel groups. For example, in California we have the Tech Coast Angels or Pasadena Angels. Thanks.

  • Chris Smith-Hill

    Helpful post Sam. If a startup does give out common stock at $.001 initially, then raises funding at say a $1M valuation, what are the tax implications for the holders of the common stock? By the way your twitter link didn’t work for me.

    • http://twitter.com/samwuiam Sam Wu

      Chris — there are no tax implications until the sale of the common stock. At issuance, the general rule is that you issue the founder’s common stock at fair market value. As long as the common stock is issued at fair market value, no tax implications. If you issue common stock below fair market value (i.e. at a discount), there are potential cheap stock tax implications. After the issuance, the only other time there will be tax liability is upon the sale of the common stock. There are no tax implications upon a fundraising event. There is one big caveat — if the founders’ shares were issued with vesting of repurchase rights, and the founder didn’t file an 83(b) tax election, then the founder could have a potential tax liability as the value of the common stock increases as the common stock vests. Hope that helps. By the way, twitter link fixed — thanks for letting me know.

  • Guest

    Sam,

  • Yvonne Dixon

    Hi Sam — Do you have to pay into a corporate bank account for common stock immediately after incorporation or is there an allowable “grace period” of sorts. For example if a company incorporates January 1st but a bank account isn’t opened until 2 or 3 weeks later you technically can’t pay for the stock until the account is opened so how should that situation be handled? Does it matter as long as the stock is paid for?

  • http://twitter.com/samwuiam Sam Wu

    Hi Yvonne,

    There is no hard and fast rule. The sooner the better, but 2 to 3 weeks should be fine. I would just date the check as of the purchase date, and then make a copy of the check to file it with the issuance to show proof of payment. For clean accounting, make sure and deposit the check and show the payment in your financials when you open the bank account. Also, make sure the check is made out to the company.

    • Yvonne Dixon

      Thanks! That’s really helpful. By the time the check clears it will probably be 4 weeks….I hope no issues are created. I was going to combine the payment for the stock and general funding for the account into one check. Do you think I should break those into 2 separate checks for clarity? Or it doesn’t matter?

      • http://twitter.com/samwuiam Sam Wu

        I would break it up into 2 different checks, and make a copy of the check to show that the shares were fully paid.

  • http://twitter.com/samwuiam Sam Wu

    I would break it up into 2 different checks, and make a copy of the check to show that the shares were fully paid.

  • Nancy

    Hi Sam, Is a company absolutely NOT allowed to have it’s first board meeting before the incorporator gives a statement of consent appointing first directors? I didn’t know about this protocol and as a sole founder I signed “written consent in lieu of first meeting” documents listing resolutions on the day we got incorporated. Among the resolutions was the issuing of stocks to myself. The problem is that the incorporator didn’t sign the written consent appointing me as the first director until the DAY after I did all this……This is only important because I filed my 83b using the incorporation date as the date the stocks were issued to me. So now I’m worried that the stocks could not have been officially issued that date because the incorporator had not appointed me yet. is there anything I can do?

    • http://www.techstartuplawyer.com/ Sam Wu

      This should be pretty simple to fix. Depending on the exact circumstances and who the incorporator is, the best solution could be different. I would suggest preparing an Action by Sole Incorporator. I’d be happy to point you in the right direction if you want to give me a call.

  • Mark

    Hi Sam,
    I have recently setup a C Corp in Delaware with 1000 auth share capital at Nil par value. I assume it is possible to have issued say 950 shares at incorp at a low value say $0.001 and then a further 50 shares later at higher price following signing of contract giving additional value to Corp. Reading your reply to Chris Smith-Hill post below it appears this is possible as long as at least done at fair market value. And the capital raised would not be taxable compared to if the full 1000 were issued then 50 subsequently sold for higher price. Thanks.

About Sam Wu

Sam Wu

Sam is a partner with Innovation Capital Law Group and specializes in startup representation, corporate finance (i.e. angel investment and venture capital financings), mergers and acquisitions and licensing transactions.

Sam is also the Founder of Q Street Startups, a tech-media startup focused on identifying the faces and telling the stories of Southern California's path-disrupting startups, players and the trends they're setting.

Email: swu@icaplaw.com

Phone +1.949.833.1828