Most companies have too few shares when they are started. It does not cost anything to have a lot of shares from the start, and it makes it easier when you raise more capital later. In this article, we explain what you should do.
A question we often get is how many shares you should have when you create a company. If you create a company in Sweden with the lowest possible share capital, 25,000 kr, in the government portal Verksamt, you get 250 shares by default. Is this good? It depends on what the company should be used for. If it is a private holding company, with only one or two shareholders, and where the ownership is not expected to change, it does not matter. But as soon as you have more than two owners, and/or plan to raise capital, the question becomes important.
Problem one: how to divide ownership?
Let us assume that you are three shareholders, A, B and C, and that the company has 250 shares. Since 250 is not divisible by three, one of the three owners will get one share more, for example like this:
- A: 84 shares
- B: 83 shares
- C: 83 shares
Some decision in the company, for example changing the articles of association and merging with other companies, must be approved by a “qualified majority”, in this case 2/3 of the shares voting. I the example above, A can get a qualified majority with either B or C, but B and C cannot get it together. This in effect means that A has a veto on such changes, whereas B and C do not.
It would be possible to solve this by having 252 shares to start with, since 252 is divisible by 3. If you do, it is important to increase the share capital by 200 kr to 25,200 kr. Otherwise, if you have a share capital of 25,000 kr and 252 shares, you will get a quota value (share capital per share) of 25,000 / 252 = 99.2063492063, that is, with 10 decimals. The problem is that the Swedish Company Registration Office, Bolagsverket, has an IT-system that can only handle six decimals. This means that it is highly likely that you will end up with a rounding error the next time you do a share issue. This in turn means that you will have to explain the situation to Bolagsverket every time you do a share issue.
Problem two: adding minor shareholders
Suppose that the company hires a person who is offerred to buy 2.5% of the shares in the company. The problem is that 2.5% of 250 is 6.25. Since you can only issue whole number of shares, it will not be possible to give the new employee the intended ownership by way of a share issue. There is also a psychological aspect to this: it feels a lot better to be offerred 6,250 shares than 6.25 shares, even though the percentage of the company would be the same.
Problem three: the company raises external capital
When a Swedish startup does it’s first share issue to external investors, the pre-money valuation often falls in the range of 5 to 50 million kr. With 250 shares, this means that each share costs between 20,000 kr and 200,000 kr. This may not be a huge problem to start with. But if the company is successful, it soon becomes troublesome. Let us take a real world example, the payment company iZettle, which started in 2010 and was acquired by Paypal in 2018.
When the company was created it had 1,000 shares, and in the first financing round they raised 18 million kr at a pre-money valuation of 40 million kr. After that, the valuation rose sharply, and in their share issue in 2015, they raised 565 million kr at a pre-money valuation of 3.5 billion kr. If they had kept the same number of shares as when they started, each share in that share issue would have cost 855,490 kr, which starts to become impracticable. It would also make it difficult to issue warrants to employees, since the smallest amount that could be awarded would be 0.1% of the company (equivalent to 1 share). If every employee in 2015 had received one single option, that would be equivalent to 3.5% of the company.
The solution to this is to do a “split”. A split means that for each old share, you receive a number of new shares. If you do a split so that you receive 1,000 new shares for each old share, you do a split “one thousand to one” (1,000:1). This is exactly what iZettle did after their first share issue. This of course solves the problem, but it makes it harder to track how much you own, since the number of shares you have now depends no only on how many shares you have acquired, but also when you acquired them, since you have to re-calculate the number if you acquired them before a split. It becomes especially problematic if you do multiple splits. Which is precisely what iZettle did – a few years after the first split, they realized that they had not gone far enough and did a new split 20:1.
Solution: many shares from the start
The solution to this problem is very simple: right from the start, you should have enough shares so that you never have to do a split. I practise, this means that if you create a company with a share capital of 25,000 kr, you should have 2.5 million shares, which is the highest number of shares you can have if you create the company through the digital portal Verksamt. If iZettle had followed this advice, they would have started with 10 million shares (since they had a share capital of 100,000 kr) and in their last share issue before they were acquired by Paypal, they would have had a share price of 146 kr, which would have been quite reasonable, even if they had gone for an IPO.
What do you do if you already have a company, and it has too few shares. Simple: do a split and create enough shares. Many companies does this, but hesitates and create “enough shares for now”, that is too few. Which in turn forced them to do another split later. It is better to go the whole way right from the start and to have a quota value of 0.01 kr (meaning 2.5 million shares if you have 25,000 kr in share capital).
Disadvantages with many shares
Are there any disadvantages with having many shares? No. The only objection tends to be that “this is not how most companies do”. However, there are no rational reasons against having lots of shares to begin with.