A question that we’re asked all the time is to explain the difference between “authorized shares” and “issued shares” or “shares outstanding”. Clients are often confused about why they have 10,000,000 shares authorized for issuance but we only issue them 2,000,000 shares upon incorporation. They believe that they, therefore, own only 20% of the corporation’s shares rather than 100% of the shares of the corporation. The simple answer to this is that the authorized share count for a corporation is only the number of shares it is legally able to issue at a given time. Even though the corporation is able to issue those shares, generally speaking, it is not obligated to and will likely never issue them.
Given that it will likely not issue these shares, why authorize them in the first place? The answer is that we authorize more shares because we want the flexibility to issue them if necessary in the future. Because you need both a board consent as well as the consent of your stockholders to amend your corporate charter (the Certificate of Incorporation in Delaware or Articles of Incorporation in California), there may be instances where the corporation would like to issue additional shares without amending the corporate charter. Examples of this would include a stock split (e.g., issuing each stockholder one extra share for each share the stockholder owns), increasing the number of shares available for issuance to employees and consultants in your stock plan or issuing options or warrants to third parties providing services to the corporation.
The other part to consider is that the authorized share count can (and likely will) change, particularly if you are a startup receiving funding from third parties. As we create new classes of stock, particularly preferred stock, the authorized number of shares of common stock will also increase to accommodate the initial 1:1 conversion ratio of the preferred stock.
In conclusion, the authorized share count could have practical implications (e.g., Delaware taxes corporations based on this number as discussed here) but it is not determinative (nor even relevant) in terms of the percentage ownership of the company. Only shares that are issued as well as convertible instruments like stock options, warrants and similar instruments are counted in determining the capitalization of a company.
