The terms “authorized shares” (or “authorized capital”) and “issued shares” are often confused, but the distinction is very important. Authorized shares refers to the number of shares of stock the corporation’s charter permits the corporation to issue.  Issued shares refers to shares the corporation has actually sold or granted to someone. Shares that are authorized but not yet issued are not counted for purposes of voting, distribution of dividends or other stockholder rights.

When a corporation is organized, the incorporator must state in the charter the number of shares of each class of stock (common or preferred) the corporation is authorized to issue. If at a later date the corporation needs to issue more shares, it must amend its charter to increase the number of authorized shares. Amending the charter requires obtaining approval of the corporation’s Board of Directors and its stockholders, and is only effective once filed with the secretary of state in the state where the corporation is incorporated.

The importance of authorized stock lies in the fact that corporations may not issue more shares of stock than they have authorized. If a corporation attempts to do so, the excess shares cannot be validly issued until the corporation amends its charter to authorize sufficient shares. The delay in issuing shares can have negative tax consequences for the corporation and/or the investor. Corporate governance problems also arise if the corporation relies on the votes of the invalidly issued shares for a later stockholder approval. If the corporation’s prospects have declined since the investor paid for the shares, the investor may even seek a refund or other concessions from the corporation to compensate him or her for the loss in value between the time of purchase and the time the shares are validly issued.

Why don’t corporations simply authorize billions of shares when incorporated? Because state incorporation fees and fees for amending corporate charters increase with the number of shares authorized, so authorizing excess shares is an unnecessary expense most startups won’t want to incur until they are ready to issue those shares.

This entry was posted on Friday, April 30th, 2010 at 1:47 pm and is filed under Corporate Formation, Legal Basics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.