Authorization of the shares: Overview, definition, and example
What is authorization of the shares?
Authorization of the shares refers to the formal approval of the number and type of shares a corporation is legally allowed to issue, as specified in its charter or articles of incorporation. This authorization sets the maximum number of shares that can be issued to investors, founders, or other stakeholders and may include common and preferred shares.
For example, a corporation’s founding documents might state that it is authorized to issue up to 10 million shares, but the company may choose to issue only 5 million initially, keeping the remaining shares available for future fundraising or stock-based compensation.
Why is authorization of the shares important?
Authorizing shares is a crucial step in forming and structuring a corporation. It defines the company’s equity structure, ensuring there are enough shares available for issuance while preventing excessive dilution.
For businesses, properly authorized shares allow for fundraising through equity sales, stock option plans, and strategic ownership structuring. If a company wants to issue more shares than originally authorized, it typically requires shareholder approval and a formal amendment to its corporate charter.
Understanding authorization of the shares through an example
Imagine a startup incorporates with an initial authorization of 5 million common shares. As the company grows and seeks funding, it decides to issue 3 million shares to investors while keeping 2 million shares reserved for future use, such as employee stock options.
Later, if the company needs to raise more capital but has reached its authorized limit, it must amend its corporate charter to increase the total number of authorized shares. This requires board and shareholder approval before any new shares can be issued.
In another scenario, a corporation might authorize 10 million shares, but only issue 6 million in its initial public offering (IPO), ensuring that additional shares are available for future capital raises without requiring immediate restructuring.
An example of an authorization of the shares clause
Here’s how an authorization of the shares clause might appear in a corporate charter or agreement:
“The Corporation is authorized to issue up to [Total Authorized Shares] shares of stock, consisting of [Number] shares of Common Stock and [Number] shares of Preferred Stock. The Board of Directors shall have the authority to issue shares within these limits and determine the rights, preferences, and privileges of any additional classes or series of stock.”
Conclusion
Authorization of shares is a fundamental part of corporate governance that defines the maximum number of shares a company can issue. It allows businesses to raise capital, incentivize employees, and manage ownership structures effectively.
By clearly outlining share authorization in corporate documents, companies can ensure compliance with legal requirements, maintain flexibility for future growth, and prevent disputes over share issuance and dilution.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.