Quantity – When authorizing shares for a Delaware Corporation, one should consider that the annual Delaware Franchise Taxes will be based on the number of shares; therefore, when possible, it is best to keep the number of authorized shares low.  A good rule of thumb is to authorize only what the corporation will need. Corporations with 5000 or less authorized shares are considered “minimum stock” and will pay the minimum Delaware Franchise tax each year. If you must exceed 5000 authorized shares your corporation will be classified as a “maximum stock”  and you will be afforded the opportunity to recalculate the company’s Franchise Tax using a complicated formula called the “Assumed Par Value Capital Method”  that will consider the company’s gross assets and the number of issued shares at the end of the year.

Par Value and Share Valuation – If you decide that you need more than 5000 authorized shares for your corporation, the Delaware Franchise Tax calculation is no longer a matter of consequence, and now the focus should shift to the par value assigned to the shares. If you must exceed 5000 shares, the next threshold for you to consider is a share valuation of $75,000. Share valuation is simply the number of Authorized Shares multiplied by the Par value. Par value is only relative to the bottom value of the share, and has no bearing on the “market value” or “stock price” of the share.   As with the number of authorized shares, generally it will be better to keep the par value as low as possible because the initial filing fees will be calculated based on the share valuation. “Minimum Stock” Corporations may consider a zero par value, but corporations in excess of 5000 authorized shares will want to assign a par value to the shares to avoid additional filing fees levied by Delaware Division of Corporations. Delaware Law will allow a par value as small as $0.000001, thus making it very easy to manipulate your company’s share valuation to remain below the $75,000 threshold. For example, if you decide you need 1,000,000 authorized shares you can assign a par value of $0.001 which will result in a share valuation (1,000,000 shares x $0.001 par value) of $1,000. Because the share valuation is less the $75,000, the corporation will not experience any additional filing fees at the time of incorporation.

Classes of Stock – Though the classes of shares have no direct influence on the Delaware Franchise Tax, it is still important to mention.  For most corporations the share class will be “Common” but the scope of Authorized Shares includes all classes (i.e. Common and Preferred). Therefore, it is important to remember that when you are considering the quantity of authorized shares or calculating the share valuation that the authorized shares are all shares combined, both common and preferred.

A Non-Profit (notice I left out corporation) is most commonly an organization that has obtained tax exemption under section 501(c)(3) of the IRS code by filing Form 1023. To qualify, the organization must be a corporation, community chest, fund, or foundation (a trust is a fund or foundation and will qualify), organized and operated exclusively for one or more of the following purposes:

•    Religious
•    Charitable
•    Scientific
•    Testing for public safety
•    Literary
•    Educational
•    Fostering national or international amateur sports competition (but only if none of its activities involve providing athletic facilities or equipment; however, see Amateur Athletic Organizations, later in this post)
•    The prevention of cruelty to children or animals.

It just so happens that many states, including Delaware, have a type of entity whose articles are designed to facilitate the application for tax exemption. Can you guess what that entity is called? That’s right, it’s the Non-stock Corporation. Do not confuse this with a Stock Corporation that has no authorized stock. Is that even possible? Yes. Even though it makes no sense, Delaware does allow Stock Corporations to file articles without authorizing shares of stock. It is rare but we have seen individuals accidentally file corporations this way. This error can be corrected, but it will cost you precious time and money!

A Delaware Non-Stock Corporation has no capital stock and is required to disclose its “non-profit” intentions in its articles of incorporation at the time of filing. It is typically used, but not exclusively, by organizations which plan to apply for tax exemption under section 501(c)(3) of the IRS code. Other applications of the Non-Stock Corporation may include civic leagues, labor organizations, business leagues, recreational clubs or other organizations that unify a common social goal; these organizations may be eligible for tax exemption under a different section of the IRS code. For more information on Tax-Exempt Status for your Organization check out IRS Publication 557. To form a Delaware Non-Stock Corporation for your non-profit organization, call us at 800-345-2677.

Common stock has two characteristics that are written in the law. They are mandatory. The first is that every share of common stock carries one vote. If you own 100 shares you have 100 votes to vote on all matters presented at Stockholder meetings.  The second is the right to your pro-rata share of any dividends issued by the Directors to the common stockholders. If the total dividend is $1,000,000 and you own ten percent of the total outstanding shares, you’re entitled to 10% of the million dollars. Common shareholders OWN the company and they have a right to share in the profits. That’s fair.

But the Board of Directors, with shareholder approval, can authorize a second class of “preferred stock” that can be issued by the Board to attract capital or top people or strategic alliances. The total number of shares of preferred stock may be split into any number of different “series” of the preferred stock, each series having its own separate terms. For example, the company may be created with 1,000,000 shares of common stock and 100,000 shares of preferred stock. The Board can designate that the preferred be split into ten series numbered 1 through 10 of 10,000 shares each and that the terms of each series can be negotiated separately and are independent of the other series.

What’s preferred about preferred stock? First, voting rights. Common shareholders get one vote per share, but you can give one or more series of the preferred stock super voting power like two votes per share, or ten or 100 or 1,000 votes per share. Why do this? Let’s say you’re creating a series of preferred to option out to key personnel. You can offer company insiders voting power this way. Or let’s say you are attracting capital from a key shareholder that already owns a big percentage of your common stock and you don’t want him to take control. So you create a series of preferred stock with NO voting rights, but a guaranteed 10% dividend paid quarterly. Your investor might be enticed to invest more money but give up any increased voting rights. Or let’s say you are raising capital and you’ve sold 45% of your stock. Once you sell more than 50% of the company you lose control. So what do you do? Bring out a series of preferred stock designated as Founder’s Stock in which the 10,000 shares have 100 votes per share. Have the Board of Directors issue the whole 10,000 shares to you. Now you can sell more of the common stock to investors and still keep control of the company. These maneuvers are sophisticated tricks and should be undertaken with the assistance of a really good corporate lawyer, obviously.

Secondly, preferred stock can have a preferred dividend over common stock. Preferred stockholders can be guaranteed a certain dividend per share ($1.00 per share, for example) or a dividend based on a business calculation that suits the deal, (x% of increase in net profits, for example). These dividends can be guaranteed, cumulative, and convertible to common stock if the deal makers agree on it and a good lawyer drafts it up right. Preferred dividends are usually paid before the common stockholders see any return.

Third, preferred stock can hold a security interest in a company-owned asset. This can include a patent, real estate, a major piece of equipment or any other company asset. Let’s say your company owns a patent that is much more valuable when combined with another patent that you don’t own. Negotiating with the owner of that patent might be a breeze if you could design a series of preferred stock with no voting rights but a security interest in your patent and a royalty from sales of the products that contain their patent.  (Or whatever you can dream up). Or let’s say the company is desperate for an influx of cash. Bankruptcy is the next step if a deal isn’t put together in time to save the company. No one will buy your common stock if you’re about to go bankrupt, but someone might invest if you gave them a security interest in the assets that will be freed up if the company goes bankrupt. I hope you never need to use that technique, but if you find yourself in that position you’ll be glad you have a Delaware corporation with blank check preferred stock.

If you’re just about to form your Delaware General Corporation and expect to sell stock in the company to raise money, it would be a good idea to consider getting the preferred stock right from the start by including it in the Certificate of Incorporation.  That way you won’t need the shareholders approval to authorize it when the time comes that you need it. The Directors will be able to issue the stock in the best interests of the company without the necessity of getting shareholder approval. If you already run a Delaware General Corporation you will need shareholder approval to amend the Certificate of Incorporation authorizing the preferred shares. If you control the common stock now, it would be a good idea to authorize this class of stock at your next shareholder meeting so that when you need it, it’ll be there.

Shares of stock are first authorized by the company’s Certificate of Incorporation (or later amendments) that state the number of shares the company has in total. Authorized means the total number you can own or sell. Authorized shares can be increased by filing an amendment to the Certificate of Incorporation with the Secretary of State’s Office. If a majority of directors and stockholders approve, you can raise the number of shares and sell them to raise capital for the company as often as you need to.

Issued shares is the number of authorized shares that have actually been issued to individuals or corporate owners of the company including founders, managers, insiders and investors.

Stock in private companies is valued differently than stock in public companies. We’ll talk more about that in later blog posts.

Just to complicate things, it must be mentioned that a Delaware General Corporation can have more than one “Class” of stock. Specifically, every corporation must start with one class of “Common” stock that is entitled to one vote per share. On top of that, you might want to consider a separate class of stock authorized as “Preferred” shares that you can use to raise money or retain power. An upcoming blog post will focus on Preferred Stock and its uses.

This blog category will help you understand stock and see how others have used it to their advantage. We invite you to join the conversation and leave a question or comment.