by Tim Berry
Most business plans, particularly start-up business plans, need to deal with shares at several key points. Shares are shares in ownership. This is why we talk about shares of stock, and we buy and sell shares on the stock market.
Now, the simplest one-person business has no need for shares because nobody is sharing anything. However, as soon as there’s a second person, then sharing is a possibility. Beyond basic partnerships are the corporations which are normally owned by shareholders, and each shareholder has some number of shares.
- How many shares should I have?
- How many shares am I allowed?
- How many shares do I give to my sister-in-law who helped with the plan?
- What about shares for my roommate, who says it was her idea?
- What will the investors think?
Questions about shares and sharing come up frequently as you develop a plan for starting a business. I’d like to help you answer these types of questions by discussing some fundamental concepts of shares that belong in a start-up business plan.
As I said, when we talk about shares we mean shares in the ownership of the company. The math of share ownership is very simple. Divide the total value or worth of the company by the number of shares, and that’s the value of each share. For example, if there are 1,000 shares of a company and you know that the company is worth $50,000, then each share is worth $50.00. The table illustration below demonstrates this. Notice that C15, Price per Share, is the product of dividing the Valuation of the company, C14, by the number of existing Shares, C13:
You can also use shares to calculate the worth of the company – known as “valuation” – by multiplying the number of shares times the price of a share. For example, say you decide to issue 100 new shares of that $50,000 company and sell those 100 shares to Aunt Mabel for $5.00 each. Consider this calculation seen in the next illustration where Valuation, cell C14, is the product of Shares multiplied by the Price per Share (C13*C15):
This simple math can affect your business plans unexpectedly. You just changed the value of the whole company, by changing the price per share of stock. You may have decided to sell to Aunt Mabel for $5.00 a share just because you like her, but in doing so you have changed the formal value of the company. Analysts, in general, and tax authorities, in particular, have little or no sense of humor about stock transactions.
There are fine points which attorneys and CPAs might add – and I’m neither – but for a lot of legal purposes, the value or worth of something is determined by what it was last bought and sold for. Therefore, in our example this company is now worth $5.00 per share. Did you undervalue it? That’s too bad. Under the circumstances perhaps a better plan would have been to give 100 of your own shares to Aunt Mabel, as a gift, instead of selling them.
An interesting point here is that nobody cares very much how many shares there are in a start-up company, at least not as an isolated number. This same example company with its 1,000 shares could have just as easily had 10 shares at $5,000 each or 100,000 shares at $0.50 each. What matters is price multiplied by total number of shares, that’s what a company is worth.
Much more important is how much of the company any given owner owns. After she gets those 100 shares in the example above, Aunt Mabel has about 9% (100/1100=.090909).
Defining Founders' Ownership
A start-up business plan involving more than one person should carefully define the stock ownership of the founders. Whether that’s 100 shares or 10 million, you need to decide who owns how many, and why. This is separate from share sales to subsequent investors, or employees, or if the business becomes publicly traded, to stock market buyers.
This isn’t specifically about the financials or the numbers inside financial tables. The financial projections in a normal business plan will include a single number called “paid-in capital” for the total dollars invested. Percentages matter a lot, of course, and ownership matters a lot. It is critical for your planning, but this description of ownership belongs in the text of the plan.
What’s fair? I get a lot of questions about fairness regarding stocks, as if there were some formulas recorded somewhere. There are no standard formulas because the possible variations are limitless. Here’s one example:
“So it’s her idea, but my money, and he’s the only one working there every day. What’s a fair division of ownership?”
I can’t tell you what’s fair in this example. I can, however, tell you this: however you work it out amongst yourselves, it should be declared in your business plan. Never, ever, get going in business without defining shares and ownership. Make sure that’s in your plan.
Having said that there are no standard formulas, I can say that personally, when I look for fairness I respect investment money a lot. I also have a strong respect for sweat equity, but only when it is defined in fair monetary value.
Shares, Valuation, and Investors
If you’re going to seek outside investors as part of your business plan, then you have to understand the underlying math. Investors want to know how much money you want for how much ownership. Consider this last illustration, which should be part of every plan seeking investment:
You can’t duck the fact that asking $2.5 million for 60% ownership in the company means that you believe your company is worth about $4.1666 million. In the real world, all of these values are the subject of negotiation. Investors rarely, if ever, accept the entrepreneurs' assumptions for future sales, valuation, investment amount or percent of ownership. You will have to support your assumptions and be ready to adjust your plan to reflect any investment agreements you reach.
The Legality of Share Distribution
We can’t leave this subject without a reminder that selling stocks is most often against the law. The Securities and Exchange Commission has a lot at stake, preventing the kinds of frauds, Ponzi Schemes and the like, that were common in the roaring twenties, and beyond. Companies spend enormous resources trying to “go public,” meaning that it becomes legal to sell stock to lots of people. If you’re thinking about an Initial Public Offering (IPO) and public stock sales, you can do some good initial research beginning with the SEC's website, www.sec.gov/answers/accred.htm, but make sure you see an attorney before you even get close to making an investment offering.