Now that you’ve decided on the co-founders’ equity allocations and are ready to incorporate a company, let’s translate those percentage allocations into actual share numbers. If you don’t have the co-founders’ allocations settled, check out the post How to Allocate Equity to Startup Founders.
How Many Shares to Authorize?
When incorporating a new Delaware corporation, I recommend authorizing 15,000,000 shares of common stock. Of the 15,000,000 authorized shares, divide only 10,000,000 shares initially between the co-founders and an option pool. The extra 5,000,000 authorized shares simply exist. They are dry powder and are not issued or otherwise reserved unless the company needs them later. For example, the company can use the extra authorized shares to add a late-joining co-founder or increase the option pool reserve if it needs to hire more people than the founding team initially expected.
What Size Option Pool Do I Need?
The option pool’s initial size is typically between 10% to 20% of the company’s originally allocated shares. In other words, the company will reserve 1,000,000 to 2,000,000 shares out of the 10,000,000 for future issuance to the company’s service providers under its option pool. Within this range, founders should select an option pool size based on how much hiring they plan to do between incorporation and the company’s first round of venture capital equity financing. At each round of equity financing, the lead investor will usually request that the company increase its option pool reserve enough to cover option grants for another 12 to 18 months of its hiring plan. (Twelve to eighteen months is the typical amount of time between equity financings.)
Now Divide the Shares Between the Founders
Divide the remainder of the 10,000,000 shares between the co-founders. To illustrate, assuming an even equity split and a 10% option pool, each member of a three-person founding team would be allocated 3,000,000 shares, with 1,000,000 shares reserved in the option pool.
Issued? Outstanding? Reserved? Fully Diluted?
After allocations are final and the co-founders have purchased their shares, they then hold “issued and outstanding” shares. Remember to file your 83(b) elections! The option pool shares are “reserved” and do not become issued and outstanding until the company awards them or sells them in the future. Although the definition of “fully diluted” can vary depending on the context, option pool shares are typically understood to be a part of a company’s fully diluted share count.
Look at This Cap Table