“We want to give Barbara 4% of the company. How many shares is that?”
I get questions like that frequently, and once you understand the math, the solution is pretty simple. Hey, I’m a lawyer, and I can understand the math. If you are going to run a successful startup, you need to master your cap table and understand basic cap table math.
First, you have to decide what is the total universe of stock that you are talking about. Is it all the shares of stock that the company could have outstanding, or is it only the issued and outstanding shares? This can provide very different results, so it is really important to use the right language. My default is that our universe is the issued and outstanding shares, unless I’m specifically told to do otherwise.
So let’s imagine a typical early stage Delaware corporation startup, with 10 million authorized shares. There are two initial cofounders, and they collectively hold 7 million shares. Their 7 million shares are 100% of the total issued and outstanding shares. That’s our starting point. If you are going to issue Barbara enough shares so she has 4% of the total, then how many shares is that? Well, after you issue Barbara’s shares, whatever number that may be, the initial cofounders will hold 96% of the total issued and outstanding shares. So 7 million shares is now 96% of X, the new number of issued and outstanding shares. Divide 7 million by 0.96. That should give you 7,291,677. Subtract 7 million from 7,291,677, and voila! You have the number of shares to issue to Barbara.
That’s how I normally do it. However, let’s say that your universe is going to be all the shares that the company could have outstanding. Maybe someone promised Barbara 4% on a “fully-diluted basis,” meaning we assume that all stock vests, and all options, convertible notes, and warrants are exercised. This is going to be a higher number. If you have 7 million shares outstanding, and options and convertible notes for another 2 million, then our total universe is 9 million shares. So now you divide 9 million by 0.96, and you get 9,375,000. Subtract 9 million from that, and the different – 375,000 – is what you need to issue to Barbara. So, depending on how you define your universe, Barbara could get approximately 84,000 more shares.
One final tip: it’s better to say “I’m going to grant you X number of shares, which will be Y% at the time of issuance,” than to say “I’m going to grant you Y% of the company.” The reason is that when you say “I’m going to grant you Y% of the company,” the recipient hears “I’m always going to have Y%, and the company will have to issue new shares to me from time to time, so I can maintain my percentage.” They think they are getting anti-dilution protection, and you want to avoid that at all costs.