How To Allocate Shares In A Startup

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At Sprintlaw, we work with a lot of startups and small businesses. A common question we get is, “How can we allocate shares in our startup?”.

We often talk about issuing shares in terms of more established companies. However, when you’re just starting out, share allocation can be a bit tricky as the company hasn’t been properly valued yet.

Let’s walk through share allocation in startups and discuss some ways you could potentially overcome this initial bump in the road.

How Do Shares Work In A Startup?

In any company, shares represent ownership. So, if someone purchases shares and becomes a shareholder, they own a percentage of the company and their rights would be set out in the company’s Shareholders Agreement.

In a startup, shares are usually divided between the founders and investors (if the company has any). The number of shares and the share price will need to be decided on first. It’s not unusual for companies to have 10,000,000 in shares of common stock as the number is easily divisible.

The agreement will largely be based on estimation as again, there’s no real way to assess each contributor’s value.

Generally, those taking a higher risk will be entitled to more shares. However, there are a lot of factors that go into determining how shares are divided between founders. The final agreement will depend on the circumstances of the company itself.

Allocation Of Shares In A Limited Company

We’ve discussed how shares work in companies generally, but do they differ depending on whether a company is private or public?

For a limited company (that is, a public company), they would be listed on the Australian Securities Exchange (ASX) where members of the public can purchase shares into their company.

This isn’t the case with private limited companies – let’s discuss this below.

How To Allocate Shares In A Private Limited Company

Allocating shares in a private limited company is a little different, as they are not listed on the ASX. Instead, a private limited company can only have 50 shareholders, where shares are distributed among them.

The shareholders will normally sign a Shareholders Agreement, which sets out rules around what shareholders can and can’t do in the company. For example, it might set out a specific process to follow if a shareholder wants to leave the company and sell their shares to other shareholders first.

If the company’s own agreement states otherwise (or no one from the company wants to purchase their shares), they can find someone willing to buy in from outside the company. Once a transaction has been completed, the shares can be transferred to the new shareholder.

Do Founders Have To Pay For Shares?

Yes, founders have to pay for their own shares in a company. Founders’ shares are usually sold at a more discounted rate than common shares because they bought into it during the company’s early days.

Depending on the agreement between founders, there are times where founders’ shares can come with different terms to common shares. For example, founders’ shares can be a different ‘class’ of shares, allowing the founders more leeway in company decisions.

This may be covered in a Founders Term Sheet, which is a document that generally acts as a stepping stone for a formal, legally binding document for founders later down the track.

How Many Shares Do I Issue To Founders?

There is no set number of shares that founders receive, as it really depends on the company itself and the agreements between all the founders. As we mentioned above, founders that have risked more for the company may have more shares compared to someone whose contributions have been relatively low-risk in nature.

In this situation, you may wish to consult a professional if you’re unsure about how many shares to allocate to your founders. Each startup is different and has its own requirements, so the way you conduct business and set things up will not be identical to another.

Do I Allocate Shares Based On Ownership Amount?

Ownership amount applies to investors that have bought shares into the company. In exchange for the capital they have put into the company, an investor will get to own part of the company through the shares they receive.

Ownership amount is calculating what is left over from the shares that have already been allocated (for example, to the founders) and then giving the investor shares from what is remaining. The shares they receive will depend on what the shares are worth and the amount of capital that was invested into the company.

How To Distribute Equity In A Startup

Equity is another way an individual or organisation can have ownership in a company. Much like shares, equity is not divided randomly. There is a vesting schedule created where equity will be distributed between the founders, investors and the option pool.

Once again, the amount of equity distributed is usually not equal but rather, it depends on what each party has contributed to the company.

What If I Hold Shares Through A Trust?

Shares can also be held through a trust. Holding shares through a trust can often be the more secure option, as it can keep your shares protected even if something else goes wrong with the company. Therefore, your funds can remain protected through a trust account.

Additionally, holding shares through a trust can also be the more tax effective option.

Shares can be held through a trust either from the beginning or moved later on (but it’s best to have a legal professional help you with this process) and then vested at a later date.

Key Takeaways

Allocating shares in a startup is somewhat different to what we usually hear regarding shares. However, there are a number of different pathways you can take according to your business’ requirements .

It’s always wise to seek the advice of a legal professional first. To summarise what we’ve discussed:

Shares are different in a startup, as nothing has been properly valued yet
Private companies allocate shares between their limited number of shareholders though agreements, such as a Shareholders Agreement
Founders have to pay for shares and how much they are allocated will depend on the company itself
Investors will gain what they put into the company, depending on what they invested on what the shares are worth
Much like shares, equity can also be distributed in the startup
Holding shares through a trust is generally poplar for its security and tax benefits

If you would like a consultation on allocating shares in a startup, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.

Sapna Goundan

Sapna has completed a Bachelor of Arts/Laws. Since graduating, she's worked primarily in the field of legal research and writing, and she now writes for Sprintlaw.

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