Why it’s important to incorporate with the right number of shares
There are two considerations when thinking about how many shares to create in your start-up and what the share price nominal value should be:
- how much cash you will have to transfer to the company, and
- the impact that the number of shares will have on the price per share your investors have to pay during a funding round.
If you’ve already made a mistake and are looking for how to fix it, skip to the end of the article.
Don’t incorporate with 1,000,000 shares of £1 each
A classic mistake is where founders create 1,000,000 shares with a nominal value of £1 per share. That means they need to have written a cheque to the company for £1M for those shares!
For the uninitiated, the nominal value of your shares is a fixed value of each share that you decide at incorporation.
Once set, it cannot be changed without also changing your share capital. In other words, you could subdivide your nominal value from £1 to £0.1, but using the example above that would also require you to increase the number of shares in your company from 1,000,000 to 10,000,000.
When you state that your company has 1,000,000 shares each having a nominal value of £1, then you’ve represented to the world that your company has £1,000,000 in the bank. Worse still, all shares in companies need to be fully paid up, so you have also created an obligation between yourself and your company where you now owe your company £1,000,000 for the 1,000,000 shares you hold.
Your paid-up capital is not the company valuation
The reason some founders mistakenly incorporate the company with, say, 1M shares of £1 each is they think they’re that by doing this they’re setting the company valuation to £1M for, say, the valuation in the next funding round. But clearly this that can’t be the case otherwise you could just make up any number of shares and that would be the company valuation!
Rather, the company valuation is a function of its future potential, whereas the paid-up capital at incorporation is simply the value the founders paid for their shares when the company was incorporated.
In many cases founders put a lot of their own money into the business and they think that this should be reflected in the incorporation paid-up capital. But no, stay with £100 in paid-up capital, and instead treat the money you put into the business as a founder loan which, if you do your next funding round on SeedLegals, we allow you to add terms for the company to repay that loan e.g. when you reach cash-flow break-even.
If you’re going to incorporate with a large number of shares, set a low nominal price per share
As mentioned, incorporating your company with 1,000,000 shares is not necessarily a problem. We see many founders do this. But the important thing to remember is that if you would like to have a large number of shares, that you need to set a small nominal value so that your total paid-up capital (the number of shares multiplied by the nominal value) is, typically, £100. That means you need to write a cheque (or wire funds) to the company for £100.
So if 1,000,000 shares, then a nominal value of £0.00001 per share would be typical.
What is the correct number of shares to incorporate with?
The short answer is you need the number of shares that results in a manageable price per share for your investors.
Here are two examples:
- You incorporate with 100 shares.
- You’ve set the valuation of your business at £1,000,000, and you are looking to raise £200,000 for 20% of your business.
- The way funding rounds work is that you have to issue new shares to investors to make them shareholders (as opposed to transferring them from the existing shares).
- Because you only had 100 shares to begin with, the maths mean that you could only create 25 new shares to offer to the new investors who are going to give you the £200,000 (because 25/125 = 20%). Therefore, that £200,00 has to be divided by the 25 shares you can offer, to get your share premium price for the funding round. That price per share would be £8,000.
- This can become a problem because it inadvertently sets up a minimum ticket size in the eyes of smaller investors, and also brings inflexibility as an investor would be unable to invest a nice round £20,000, they would be forced to invest either £16,000 or £24,000.
- If you started with 100,000 shares instead, you can divide the £200,000 investment target by 25,000 instead of by 25 as above. This gives you a share price of £8 per share in your new round.
- This is a much more manageable price that does not price out any small investors and effectively will allow all investors to invest exactly the amount they wish.
- Therefore, if you incorporate with enough shares in the company so that problems do not arise later on when you go to raise funds and a nominal value that is low enough so that you do not owe your own company an arm and a leg.
- If you’re looking for a guide on how to incorporate your company, we have written one that you can use alongside the Companies House online application portal here.
How to fix incorporation mistakes
If you incorporated with, say, 100 shares of £1 each, that’s not a mistake, that’s actually the default way of doing things, and your next step is to do a share split, which you can do in a few minutes on SeedLegals, easy.
But, if you incorporated with a paid-up capital of, say, £1M, clearly you can’t actually pay for those shares, so you’ll need to fix that in some other way. And there are two ways to do that:
Option 1: Make a new company
If all you have done to date is incorporate your company, but nothing else, all you will have lost is:
- a bit of time,
- £13 (if done with Companies House), and
- The chance to use the same company name again.
If that does not matter to you, the easiest is to create a new company, with a new name, but this time incorporate with an appropriate number of shares and an appropriate nominal value.
We’ve written a guide on how to incorporate a company with the Companies House online application portal here.
Alternatively, if your company already has IP, has been trading, has other shareholders, etc., then you might want to keep that company rather than starting again.
In this case there’s a process you can fill out an SH19 form that allows you to reduce your share capital. The form needs to be accompanied by a director solvency statement, a written resolution and also a statement of compliance. Once all forms a filled in you need to send them to: Company House, Crown Way, Cardiff, CF14 3UZ.
The process costs £10 and will take up to 7-10 working days. There is a £50 option for 1-day delivery, but due to COVID they are currently not offering this service.