Private Company Stock

Figuring out share price for public companies is a snap. But for private companies, stock pricing can be a complicated and costly process. Inc.'s finance editor offers help in addressing the important issues involved in private stock.

Finance 101

How many shares should you issue? How do you price them? It all depends on what you're up to

"Back in 1993, I incorporated my company, mainly in the interest of liability protection," says Tim McCorry, chief executive of the McCorry Group, a $2-million manufacturer of sports fitness products in Berwyn, Pa. Back then, McCorry says, "I knew I wanted to get out of the starting gate clean, grow my business, and one day bring in investors. But I didn't know about such things as how many shares of stock the company should have or how much they should be worth. I looked to my attorney for guidance on that point."

McCorry is not alone. Of course, it's a snap to tell how much one share of a public corporation is worth. Just pick up a newspaper or log on to one of the proliferating market-watch Web sites. Stock-price swings are easy to track and quantify. With private companies, though, stock pricing is a complicated and usually costly proposition -- one that is tied to today's realities, future prospects, and, above all, the owner's motivation for coming up with a price. Still, despite the complexities, it is an important issue for entrepreneurs, especially those who, like McCorry, intend to one day raise growth capital from outside investors.

To demystify matters, let's start at the one point in time when a private company's stock situation is straightforward: incorporation. Generally, in an incorporation an owner, with a lawyer's assistance, chooses a corporate structure and files the necessary paperwork with the secretary of state's office. If the filing occurs before start-up, the company has no book value, except whatever initial investment has been made in it. That means that you and your attorney can set an initial stock price without supplying any additional information (for example, about ongoing operations or current assets).

At this early phase, the company's attorney typically makes a recommendation about whether the stock should have what's known as a "par" (or stated) value or no-par value. "This decision has no impact on the way you'll run your business in the future," emphasizes Richard Yanofsky, a partner in the Boston office of law firm Holland & Knight. But that doesn't mean the decision is insignificant, because it might have tax or accounting consequences, depending on the state in which you incorporate. "If I were incorporating a business in Massachusetts," Yanofsky says, "I'd probably choose a no-par value for a company's stock, since it's easier to account for. But in Delaware, you'd calculate some kind of par value, based on the initial capitalization, because that could lead to certain tax savings."

The more important issue, at this early stage, is how many shares will be authorized (that is, registered with the secretary of state) and how many will be issued (actually transferred to the entrepreneur and any minority owners). Those two numbers are not necessarily the same -- in fact, they often are different. Here again, lawyers usually take the lead after talking with entrepreneurs about their future plans. (See "Taking Stock of Your Priorities," below.)

The possible permutations are endless. "Let's say your company authorizes 1,000 shares in total and there are two equal owners, you and your partner," explains Michael Trabert, a certified public accountant and certified valuation analyst with CBIZ-SMR Business Services, a financial-consulting firm in Mayfield Village, Ohio. "Of those authorized shares, you might decide to issue a total of 600, divided equally between you and your partner. You might never issue the remaining 400 shares, or you might decide to issue some portion or all of them if your company decided to bring in outside investors or a third partner." You or your partner might even decide to sell (or gift) some of your 300 shares, rather than tapping into that unissued pool; it's up to you to decide. (See "Deciding Which Shares to Share," below.)

In many states, incorporation fees are generally tied to the number of shares authorized. So Yanofsky, for one, generally chooses to authorize the highest possible number for the lowest filing fee, which is generally more than 100,000 shares for around $200 or $300. "That gives the owner plenty of room to maneuver at a later stage if he begins to bring in investors or award stock to key employees," he says.

Regardless of the number of shares that are authorized, a lawyer will typically recommend issuing only 100 or 1,000 shares to a single owner. "There's no point in complicating matters," Yanofsky explains. "What you mainly want is a nice round number for the entrepreneur, which makes it simple to calculate smaller percentages if shares are going to be issued to somebody else at some point in the future."

Although it's essential to keep your corporate structure clean and state registration documents accurate and up-to-date, there's no point in making yourself crazy by attempting to design an initial stock structure that will accommodate every possible capital change that could occur as your company grows. Some people (mainly friends, family members, small angel investors, or key employees) will probably accept already authorized but unissued shares if they decide to make an investment; but venture capitalists and other professional investors likely will insist on a new capitalization scheme that will provide them with extra privileges and protections. At that point you'll need to amend your corporate documents, which will include a new description of your stock plan. Again, the fee will be based in part on the number of shares authorized.

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