A (really) simple guide to shares and equity for startups
- August 2, 2023
- 5 min read
Starting a business is an exciting and challenging journey with founders dreaming of success.
However, success in the startup world requires more than just a great initial idea and hard work.
It requires a solid understanding of financial management, including how to raise funds and manage cash flow.
One important tool to achieve this is through startup shares.
While it may seem daunting at first, shares can be a valuable way to raise capital and build a strong foundation for your business – and give shareholders equity in a startup.
In this article, we will provide a simple guide to shares for early-stage startups, including what they are, how they work, and why they matter.
Whether you’re a first-time entrepreneur ( we promise to take it slow!) or a seasoned pro, this guide will help you navigate the world of shares and take your startup to the next level.
We’re going to start with some basic definitions –
What are shares?
Shares represent how much ownership (company’s stock) is in a proprietary limited company.
Startup founders may issue shares. This divides its ownership into small pieces that are sold to investors.
Shareholders who purchase these shares become part-owners of your company and are entitled to rights, such as voting on company matters, receiving dividends, and potentially receiving a portion of the proceeds if the company is sold or liquidated.
The value of a share in private companies can fluctuate based on performance, industry trends, and economic conditions.
What is share capital?
Share capital in startup companies refers to the amount of money raised by a company through the sale of shares to its investors.
When a company is formed, it issues shares to its founders, the initial shareholders. As the company grows and requires additional funding, it can issue more shares to new investors, such as angel investors, venture capitalists, or even the general public through an Initial Public Offering (IPO).
The share capital is the total value of all the shares issued by the company. It is an essential component of the company’s balance sheet and represents the permanent funding available to the business.
Why is share capital important? It can be used by the company to fund its operations, invest in new projects, or pay off debts. Startups often rely heavily on share capital to finance their growth, and it is a critical factor in determining the company’s valuation and potential for success.
What is issued share capital?
Issued share capital refers to the portion of a company’s authorised share capital that has been sold or issued to shareholders.
Authorised share capital is the maximum number of shares a company is permitted to issue, as defined in its articles of association.
When a company decides to raise funds through shares, it issues a specific number of shares to investors, which become the issued share capital. For example, if a company has an authorised share capital of 1,000,000 shares and has issued 500,000 shares to its shareholders, its issued share capital is 500,000.
It is a key metric in determining the ownership structure and value of the company. It calculates the company’s earnings per share (EPS) and other financial ratios that investors use to evaluate its performance.
What is Paid-up capital?
Paid-up capital in a startup refers to the amount of share capital that has been fully paid by the shareholders to the company. It is the portion of the total authorised share capital that has been issued by the company.
When a startup issues shares, the shareholders may pay for their shares in one or more instalments, with the remaining amount paid later. Paid-up capital represents the portion of the share capital paid in full.
Paid-up capital is an important metric for startups as it indicates the amount of capital available for the company to use for its operations and growth.
A high paid-up capital may indicate that the company has strong investor support and confidence in its potential for growth.
Paid-up capital is also used to calculate the company’s net asset value (NAV), which is the value of the company’s assets minus its liabilities. The NAV measures a company’s financial health and is watched by investors and creditors.
What is Paid-up capital used for?
Paid-up capital in a startup is an important source of funding that the company can use for business growth – to finance its operations, investments, and growth.
Here are some of the ways in which paid-up capital is used by startups:
Working capital
Paid-up capital funds the operations of the startup, such as paying for rent, salaries, and other expenses.
Product development
Startups often need to invest in research and development to create new products or improve existing ones. Paid-up capital is used to finance these efforts.
Marketing and sales
Startups need to create awareness of their products and services to attract customers. Paid-up capital funds marketing campaigns, hire sales teams, and expand distribution channels.
Acquisitions and partnerships
Startups may want to acquire other companies or form partnerships to expand their market reach or acquire new technologies. Paid-up capital finances these transactions.
Capital expenditures
Startups may need to invest in capital assets such as equipment, software, and facilities to support their growth. Paid-up capital can be used to fund these investments.
It’s important for your startup to use their paid-up capital wisely and efficiently to maximise their return on investment and achieve their growth objectives. Paid-up capital should align with your startup’s business strategy and financial goals, and manage it to ensure that the company has sufficient capital to fund its ongoing operations and future growth.
Think we need to use an example here to explain all these terms?
Sure do!
Let’s say that NextGen Up Start is a new technology company looking to raise capital to fund its operations and growth.
The company issues 1,000,000 shares of common stock with a fair market value of $1.00 per share. Here’s what the share capital structure of NextGen Up Start might look like:
Authorised share capital – 1,000,000 shares
The maximum number of shares and startup equity that NextGen Up Start is authorised to issue under its articles of association.
Issued share capital – 500,000 shares
Out of the 1,000,000 shares authorised, NextGen Up Start has issued 500,000 shares to investors. This represents the actual startup equity of the company that is owned by its shareholders.
Paid-up share capital – $250,000
If we assume each share was sold at its fair market value of $1.00, the paid-up share capital of NextGen Up Start would be $250,000. This represents the total amount of money that the shareholders have paid for their shares.
To summarise, NextGen Up Starts has an authorised share capital of 1,000,000 shares, issued 500,000 shares, and received $250,000 in paid-up capital from its shareholders.
The company can use this capital to finance its operations, invest in product development and marketing, and pursue growth opportunities. As the company grows and its financial needs change, it may issue additional shares or buy back shares, which would affect its issue and paid-up share capital.
Got it?
It’s now time to discuss your startup.
Here are some questions a lot of our clients ask when they are starting their new business – and we think they may help you!
How many shares shall you issue to start your company?
There is no minimum or maximum number of shares that your startup can issue at incorporation.
Startups typically issue a relatively small number of shares to a small group of initial shareholders, such as the founder, co-founders, venture capital companies, early investors, and advisors. The number of shares issued may increase as the company grows and needs more capital to fund its operations and expansion.
The articles of association lists the number of shares your company can issue at start up.
The authorised share capital is the maximum number of shares that a company can issue, and this is set at incorporation.
The authorised share capital is usually determined based on the needs of your business and the amount of capital the company expects to raise from its shareholders. Note, the actual number of shares issued at incorporation may be lower than the authorised share capital.
Don’t forget to consider the number of shares issued as it can affect the ownership structure of your company and the voting power of the shareholders.
Can you issue more shares later?
Yes, if your startup needs more capital to finance its operations or expand its business, it may issue more shares to raise additional funds.
Issuing more shares at a later stage, even after it has been incorporated and has already issued some shares is known as a secondary offering or a follow-on offering.
The process of issuing more shares involves obtaining approval from your board of directors and the shareholders, as well as complying with the relevant laws and regulations governing the issuance of securities.
The successful startup may need to prepare a prospectus or a private placement memorandum (PPM) to provide information about the new shares, startup equity, and the company’s financial and business performance.
Your startup should carefully consider the potential impact on your shareholders and the overall share capital structure before issuing more shares as it can dilute the startup’s equity percentage and the voting power of the existing shareholders.
It should align with the company’s long-term financial and business goals.
Is it possible to issue shares now and pay for them later?
Yes, it is possible for your startup to issue company shares and allow the shareholders to pay for them later, but this would require the company to structure the share issuance as either an instalment purchase agreement or a deferred payment agreement.
What is an instalment purchase agreement?
A financing arrangement allowing shareholders to pay for the shares over a specified period, typically with interest. Your company would need to provide the shareholders with a written agreement that specifies the terms of the instalment purchase, including the amount of the payments, the interest rate, and the duration of the payment period.
What is a deferred payment agreement?
A financing arrangement allowing shareholders to delay payment for the shares until a specified date. The company would need to provide shareholders with a written agreement that specifies the terms of the deferred payment, including the payment date, the interest rate, and any other relevant conditions.
Issuing shares under a deferred payment or instalment purchase agreement can create additional risks for the company, such as the risk of non-payment by the shareholders.
Therefore, consider potential risks and benefits of these financing arrangements before proceeding with a share issuance that includes deferred or instalment payments.
How do you offer employees shares in your startup?
Offering employee equity in a startup can be a great way to incentivise and retain talent, as equity compensation, while also aligning their interests with the success of the company.
Here are some steps to offering employee equity in a startup:
- Determine the type of share plan – There are different types of share plans to offer equity compensation, such as employee share schemes, employee share option plans, early employee compensation packages, and employee share purchase plans. Understand the differences between an employee equity pool and choose the one that best suits the startup’s goals and objectives.
- Decide on the eligibility criteria – Decide on the eligibility criteria for the equity compensation, such as the job title, seniority level, or length of service required to participate in the plan. For example, an experienced business development employee may be offered more equity than an admin worker. Ensure that the eligibility criteria are fair and transparent.
- Determine the share allocation – Decide on how much equity to allocate to each eligible employee. This can be based on the employee’s contribution to the company, their seniority level, or their potential to drive future growth.
- Prepare a shareholder agreement – Once the shares have been allocated, prepare a shareholder agreement outlining the rights and obligations of the employees and the company. It should cover key issues such as transfer restrictions, vesting schedules, and voting rights.
- Comply with relevant regulations – Comply with all relevant regulations and legal requirements such as the Corporations Act and the tax laws. Seek professional advice to ensure compliance with these regulations.
- Communicate with employees – Communicate the details of the equity compensation plan to the eligible employees such as their vesting schedule and equity grant. Provide them with the opportunity to ask questions and seek clarification, to help to build trust and confidence in the company’s leadership and vision.
By following these steps, startups can offer employee stock options and equity in a fair and transparent manner, while also aligning the interests of employees with the long-term success of the company.
Sleek’s tips for issuing startup equity in Australia
Before company founders issue shares in their startup, check out our list of tips –
Seek professional advice.
Seek professional advice from lawyers, accountants, and financial advisors who specialise in share issuances and startup equity distribution to ensure you comply with all relevant regulations and legal requirements.
Understand the different types of shares.
In Australia, there are different types of shares, such as ordinary shares, preference shares, and redeemable shares. It’s important to understand the differences between these types of shares and how they can affect the company’s ownership structure, startup equity, and financing options.
Prepare a shareholder agreement.
A shareholder agreement is a legal document that outlines the rights and obligations of the shareholders and the company. Prepare a comprehensive shareholder agreement to address issues, such as share transfer restrictions, voting rights, and dividend policies.
Consider the impact of share issuances on existing shareholders
When issuing new shares, consider the potential impact on ownership percentage, startup equity, and voting power of existing shareholders. Startups should communicate with their existing shareholders and obtain their approval before proceeding with a share issuance.
Ensure compliance with ASIC regulations
The Australian Securities and Investments Commission (ASIC) regulates the issuance of securities in Australia. You must comply with all relevant ASIC regulations, such as preparing a prospectus or disclosure document for certain types of share issuances.
Keep accurate records
Keep accurate records of all share issuances, including the number of shares issued, the share price, and the identity of the shareholders. These legal documents are important for tax and compliance purposes, and can also help you track your ownership structure over time.
Share equity is a powerful tool for your startup, and when used effectively, it can help you achieve your growth objectives and create value for both the company and its shareholders. Sleek helps you as a startup founder, to understand the basics of share equity so your startup can navigate the complex world of share issuances and maximise your chances of success.
Ready to startup in Australia? Call us now on +61 2 9100 0480 or use our chatbox if you’ve got a question.
