Importance of Using Exact Share Numbers Instead of Percentages

When you launch a startup business, you will likely need to recruit some serious talent to make the business venture work. You will want people who know what they are doing and are experts in their field. Usually, these people already have jobs, so you might have to lure them away from their existing job security. 

One common tactic for getting skilled personnel to take a risk on your startup venture is to offer them a piece of the company. Although it is generally easier to make an offer that involves percentages, doing so could be a mistake that causes significant headaches later. A Maryland business attorney can draft the documents your company needs and answer your questions about the importance of using exact share numbers instead of percentages. 

Things Can Move Quickly in a Startup

You want your fledgling business to succeed, and if it does, you might find yourself giving away much more value than you originally intended. The lag time between making an offer of, for example, 3% of the company and the approval and issuance of the equity could make a significant difference in the value of that portion of the company.

If there is little passage of time between making the offer and approving and issuing the shares, there might not be a problem. In many startups, however, the founder has 1,000 other things on the to-do list that need immediate attention.

Defining the Date of the Company Valuation

It is the nature of a free-market society the value of a business can change over time. For example, owning 3% of the original shares of Coca-Cola from 30 years ago would mean something quite different from owning 3% of the shares of Coca-Cola today. It is vital that any offer of a portion of the company defines the date of the valuation. 

Let’s say your startup company had authorized 100,000 shares as of the date you made the offer to a new hire of 3% of the company. The new hire would receive 3,000 shares based on the value of the company on that date. 

Unfortunately, the offer did not specify the date to use when determining the value of the company. By the time you and the new hire concluded your negotiations, reached an agreement, and the new hire gave notice at their current company and actually came on board at your startup, five months had passed. During those five months, your company had authorized another 100,000 shares. If your new hire insists that 3% of the company on day one of their employment with you entitles them to 6,000 shares, not 3,000 shares, there might be a problem.

How Using Exact Numbers of Shares Helps You Avoid Problems

You will not have to worry about the date of valuation if your offer used exact numbers of shares being offered to the new hire instead of a percentage of the company. An offer of 3,000 shares of the company is unambiguous, unlike an offer of 3% of the company. 

Using specific numbers also helps you avoid discontent among the ranks if they compare the equity they received with each other. Imagine you made equity offers to new hires based on percentages, not specific share numbers. People who were part of the company early on might receive only 3,000 shares, representing 3% of the company, while people who came on board significantly later might receive 6,000 shares for their 3% of the company. Needless to say, the people who took a risk on you on the ground floor of your venture might be disgruntled in this scenario.

Ongoing Percentages

Sometimes, the person who founds a startup company uses a DIY kit for issuing shares of the business. If the person who fills out the prefab stock certificates does not know what they’re doing, they might write a percentage of the company on the form rather than a specific number of shares. When this happens, the person receiving the stock certificate might interpret the document as granting them the right to 3% of the company in perpetuity, as opposed to the date the company issued the stock certificate. 

Usually, interpreting “in perpetuity” is not at all what the company founder intended. The rules of construction of documents will sometimes interpret ambiguous terms in favor of the party who did not draft the document. The person who created the document was in the best position to include the terms that were favorable to them. If a court followed this rule of interpretation, the stock certificate might be held as “in perpetuity” rather than on the date the stock certificate got issued.

Additional Reasons Why Avoiding Ambiguous Terms Matters

One day, you might want to take your company to another level by entering into additional investment agreements or another business deal. The other party to the deal could insist the ambiguous terms get resolved before the deal goes through. It can be reasonable for the other party to insist on such details, so the other party knows the precise nature of ownership of your company.

You will not have much bargaining power if the new hire insists on interpreting the ambiguous terms you might find to be less than reasonable. Rather than losing the investment deal, you might have to give in to the new hire. Of course, because disagreements like this can damage the working relationship between the founder and an employee, the ultimate result could be having to buy out the employee’s interest under unfavorable and possibly unfair terms from your viewpoint. 

These examples illustrate just a few of the adverse outcomes you could experience if you try to handle sophisticated document creation for your company without the guidance or advice of an attorney. Often, the money spent on having a professional do the job more than pays for itself in avoiding expensive mistakes.

A Maryland business attorney can provide the legal services your company needs to grow and stay viable. Talk to Steve today about your new venture.