Shares are created through a sequence of legal steps: the corporation’s charter first authorizes a maximum pool of stock, the board of directors then votes to issue a specific number of those shares to specific people in exchange for something of value, and the company records the transaction in its stock ledger while satisfying federal and state securities laws. No share exists until the charter permits it, and no person owns one until the board formally issues it. Understanding how shares are created matters because a misstep at any point can produce stock that is legally void, trigger securities violations, or leave the recipient with a tax bill they never saw coming.
Authorizing the Share Pool in the Charter
A corporation comes into existence when its founders file a charter with the state, usually called the articles of incorporation or the certificate of incorporation. Among other required details, that document must state the maximum number of shares the company is permitted to issue. This ceiling is the company’s authorized shares, and it sets the outer boundary for every equity transaction the company will ever undertake. Shares issued beyond the authorized number are void.
The founders pick the number. It can be a few thousand or hundreds of millions. A common pattern is to authorize 10,000,000 shares at formation, issue a fraction of them to the founders, and keep the rest in reserve for future investors, employees, and acquisitions. Raising the authorized count later is possible but requires a charter amendment, another state filing, a board vote, and usually shareholder approval.
Authorized, Issued, and Outstanding
Three terms describe different stages in a share’s life. Authorized shares are the total pool the charter permits. Issued shares are the portion the board has actually granted to someone. Outstanding shares are the issued shares currently in investors’ hands, minus any the company has bought back. Repurchased shares, called treasury stock, remain issued but carry no vote and receive no dividend.
Outstanding is the number that matters in practice. Ownership percentages, voting power, and earnings per share are all calculated against outstanding shares, not the authorized pool. When a founder is described as owning 40% of a company, that figure comes from the outstanding count.
A Warning About Filing and Franchise Costs
Filing fees vary by state. Some charge a flat amount, others scale the fee to the number of authorized shares or the stated capital. More consequential is the ongoing franchise tax: several states calculate the annual bill using the authorized share count. A company that casually authorizes 100 million shares to “leave room for growth” can face annual tax bills many times larger than a company that authorized a more conservative number. Weigh the convenience of a large pool against the recurring cost before filing.
Defining Classes and Par Value
The charter also decides whether the company will have one class of stock or several, and it sets the par value for each class. Both choices need to be made before any share is issued, because they define what the issued share actually is.
Most corporations start with a single class of common stock: one vote per share, equal claim on profits. When outside investors come in, they often negotiate for a separate class of preferred stock. Preferred typically gives up voting rights in exchange for a fixed dividend, priority in a liquidation, and sometimes a right to convert into common at a set ratio. Some companies add further tiers, such as executive shares carrying multiple votes each, that let founders keep control even as their economic stake falls below 50%. Every distinction must appear in the charter or the bylaws. Vague terms invite litigation during a sale or dissolution, when the payment order suddenly matters.
Par value is a minimum price per share written into the charter, and it confuses people who assume it reflects what the stock is worth. It does not. Companies set par at a trivial figure, often a fraction of a cent, precisely so it never constrains a future transaction. If par were set at $5.00 and the company later needed to sell shares at $3.00 to raise emergency capital, it would face liability for issuing below par. The total par value of all issued shares forms the company’s legal capital, a floor the corporation must retain to protect creditors. A million shares at $0.01 par gives $10,000 in legal capital. Many states also allow no-par stock, though setting par at a penny achieves essentially the same result.
The Board Resolution That Actually Creates the Shares
Authorized shares are only potential equity. They become real equity when the board of directors votes to issue them. This is the act that creates ownership.
At a board meeting, the directors review a proposal to issue a defined number of shares to named recipients, whether those recipients are founders putting in initial capital, employees receiving equity compensation, or outside investors writing checks. The directors adopt a written resolution recording who is getting shares, how many, and what the company is receiving in return. They vote, and the corporate secretary logs the approval in the minutes. Without this step, there is no issuance, no matter what side agreements the parties have signed.
Consideration: What the Company Gets in Return
The value exchanged for the shares is called consideration, and the board must determine that it is adequate before approving the issuance. Cash is the simplest form. Consideration can also be property, intellectual assets, or past services. The board has broad discretion in valuing non-cash consideration, and courts generally defer to that judgment as long as the process was not fraudulent. The one hard floor is par value: the company cannot accept consideration worth less than the aggregate par value of the shares being issued.
Founder grants are where this step is most often botched. When co-founders take millions of shares in exchange for an idea and sweat equity, the board still has to go through the process and document its reasoning. Skipping the resolution, or failing to record adequate consideration, can make the shares voidable. That surfaces as a serious problem during diligence before an acquisition or an IPO.
Stock Purchase Agreements
Anything beyond a simple founder grant is usually paired with a stock purchase agreement. The contract sets the purchase price, the representations each side is making about the company’s condition, the consequences if those representations prove wrong, and the conditions that must be met before the deal closes. It also allocates risk through restrictive covenants and indemnification provisions. A straightforward angel investment might run a few pages. A later-stage round stretches well beyond that.
Complying With Securities Law
Every share is a security. Under the Securities Act of 1933, every offer and sale of securities must either be registered with the SEC or qualify for an exemption from registration.1U.S. Securities and Exchange Commission. Exempt Offerings A private company issuing shares to founders and a handful of investors is still selling securities and needs a legal basis to do so without filing a full registration statement.
The Exemptions Private Companies Actually Use
- Rule 506(b) is the workhorse for private placements. A company can raise an unlimited amount from an unlimited number of accredited investors, plus up to 35 non-accredited investors who are financially sophisticated enough to evaluate the risks. No general advertising or public solicitation is permitted. If any non-accredited investors participate, the company must provide detailed disclosure documents similar to those in a public offering.2U.S. Securities and Exchange Commission. Private Placements – Rule 506(b)
- Rule 506(c) is similar but permits general solicitation. The tradeoff is that every purchaser must be an accredited investor, and the company must take reasonable steps to verify that status.1U.S. Securities and Exchange Commission. Exempt Offerings
- Rule 504 allows offerings up to $10 million in a 12-month period, often used for smaller regional raises.1U.S. Securities and Exchange Commission. Exempt Offerings
- Rule 701 is separate and covers stock issued to employees, consultants, and advisors as compensation rather than as a capital raise. Companies can issue at least $1 million under this rule regardless of size, and more under formulas based on assets or outstanding shares. If sales exceed $10 million in a 12-month period, additional disclosure is required.3U.S. Securities and Exchange Commission. Employee Benefit Plans – Rule 701
An accredited investor is an individual with a net worth over $1 million excluding a primary residence, or income exceeding $200,000 individually or $300,000 jointly with a spouse in each of the two prior years, with a reasonable expectation of the same in the current year.4U.S. Securities and Exchange Commission. Accredited Investors
Filings, State Law, and Getting It Wrong
Companies using any Regulation D exemption must file a notice on Form D with the SEC within 15 days after the first sale in the offering.1U.S. Securities and Exchange Commission. Exempt Offerings Securities issued under these exemptions are restricted, meaning the recipient cannot freely resell them on the open market without their own registration or exemption.
State securities laws, known as blue sky laws, sit on top of the federal regime. A federal exemption does not automatically satisfy state-level rules, so companies typically need to file notices or claim exemptions in every state where their investors reside.
Issuing shares without proper registration or a valid exemption exposes the company and its leadership to civil and criminal liability. Investors have a right of rescission, meaning the company must return their investment plus interest. The SEC can impose financial penalties, and in serious cases individuals face incarceration. The company and its principals may also be hit with “bad actor” disqualification, which bars them from using the most common exemptions in future fundraising.5U.S. Securities and Exchange Commission. Consequences of Noncompliance
Tax Rules When Shares Are Issued for Work
Shares sold for cash at fair market value trigger no immediate tax. Shares issued as compensation are different, and the timing rules catch many recipients off guard.
Under 26 U.S.C. ยง 83, when property, including stock, is transferred to someone in connection with services they performed, the recipient owes ordinary income tax on the difference between what they paid for the stock and its fair market value. The timing is what matters. If the shares are subject to a substantial risk of forfeiture, such as a vesting schedule that requires the recipient to keep working for a set number of years, the tax is deferred until the shares vest.6Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection with Performance of Services
The problem shows up at any growing startup. You receive shares worth $0.10 each. By the time they vest three years later, they are worth $5.00 each. You owe ordinary income tax on the $5.00 value at vesting, not the $0.10 value at grant. If the company has grown substantially, the deferred bill can be enormous.
The 83(b) Election
Section 83(b) provides an escape. Within 30 days of receiving the shares, the recipient can file an election with the IRS choosing to pay tax immediately on the stock’s current value rather than waiting until it vests. For an early-stage founder receiving shares worth almost nothing, the election can mean a trivial tax bill now instead of a large one later. If the 30th day falls on a weekend or legal holiday, the deadline extends to the next business day.7Internal Revenue Service. Form 15620 – Section 83(b) Election
The election also starts the clock on long-term capital gains treatment immediately, rather than at the vesting date. The tradeoff is real: if the shares are later forfeited because the recipient leaves before vesting, the tax already paid is gone. The election is irrevocable.6Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection with Performance of Services Missing the 30-day window is one of the most common and expensive mistakes in startup equity. There are no extensions and no exceptions.
Recording the Shares Once They Exist
After the board issues the shares, the company must record the new ownership in its stock ledger. This internal register is the definitive record of who owns what. The corporate secretary or a designated officer enters each shareholder’s name, address, the number and class of shares, the issuance date, and any certificate number attached to the grant.
Stock certificates, whether physical or electronic, serve as the shareholder’s proof of ownership. Paper certificates are increasingly rare; most companies now use electronic records that simplify transfers and eliminate the risk of losing a document. Certificates typically show the corporation’s name, the state of incorporation, the share class, and any restrictive legends required by securities laws, such as a notation that the shares are restricted and cannot be freely resold.
The stock ledger tracks individual ownership. A capitalization table, or cap table, shows the full equity structure: every class of shares, every grant, vesting schedules, option pools, convertible instruments, and the resulting ownership percentages on both a current and fully diluted basis. A spreadsheet works for a two-founder company. After multiple funding rounds with different share classes, liquidation preferences, and an option pool, cap table management gets complicated fast. Errors surface at the worst possible moments, usually during diligence for an acquisition or a new round.
What Issuance Does to Existing Owners
Every time the board issues new shares, the ownership pie is sliced into more pieces. If you held 1,000 of 100,000 outstanding shares, you owned 1%. If the company issues another 20,000 shares to a new investor, you still hold 1,000 shares, but your ownership drops to roughly 0.83%. Voting power and per-share claim on future earnings shrink by the same proportion.
This dilution is not inherently bad. When new shares sell at fair value and the company puts the proceeds to productive use, every shareholder can end up with a smaller slice of a much larger pie. The danger arises when shares go out below fair value or when insiders arrange issuances that disproportionately benefit themselves.
Preemptive rights are the main contractual defense. When the charter or a shareholder agreement grants them, existing holders get the first opportunity to buy newly issued shares in proportion to their current stake before those shares are offered to outsiders. Preemptive rights are not automatic in every corporation, so investors in private companies often negotiate for them explicitly.
Transfer Restrictions Attached at Issuance
Creating a share is only the start. Most private companies immediately restrict what shareholders can do with their equity, and those restrictions are documented in a shareholder agreement signed at the time of issuance. A right of first refusal is common: any shareholder who receives a purchase offer from an outside party must first offer the shares to existing shareholders on the same terms. Related provisions include tag-along rights, letting minority holders sell alongside an exiting majority holder, and drag-along rights, letting a majority holder force minority participation in a sale of the whole company.
These contractual restrictions layer on top of the securities-law limits already built into restricted stock. Together they mean shares in a private company are far less liquid than public stock. Anyone accepting shares in a private corporation should understand both the legal and contractual barriers to selling them before assuming the equity can be quickly converted to cash.