When you create your startup company, it is often with the expectation that your business will grow both financially and in size, eventually being able to issue shares as a private company.
For that to happen, you may need investors and partners to help you at the start of your business. Investors, partners, and individuals who all contribute either skills, capital, ideas or assets can effectively boost the growth and development of your company.
In return for their added value, it is often a common and appealing option to give these individuals shares in your Canadian startup instead of paying them in cash.
To do so, you will need to consider the value of your shares before you even incorporate your business as you will need to state your authorized shares at the time of incorporation.
The main question is: how do you put a value on your shares? We provide you with answers with this overview on the basics: what to consider, what you should know, and some general methods on how to determine that price value.
Before you can start putting a value on your shares, you first need to look at the bigger picture to help put your share value into context. This includes things like business ownership, the amount of shares, and the value of the business.
How do you Structure Ownership in a Startup?
For startups, business ownership is the most important factor to discuss at the very beginning as it determines the number of shares each person owns. In other words, you need to decide how much control each person will have over your startup. For example, you may decide to split the ownership at 50/50 with one partner, or maybe split it three ways with an investor.
When shares are issued to new shareholders in Canada and Ontario, the board of directors does so by a resolution process (coming to a decision), and can only issue shares for and after “full consideration,” that is, in return for the new shareholders’ payment or assets such as cash, property or services – details that should be outlined in a well-drafted shareholder agreement. Because of this, you need to consider the weight and value you will assign to those contributions in terms of shares and ownership.
Note that when dealing in new shareholders, you dilute and lower the share’s value, and hence your controlled ownership. This usually happens when a new investment occurs, for instance.
How many Shares should a Startup Issue?
Unless specified in your articles of incorporation, corporations can have more than one type of share or class of shares issued, and the amount of each class you can issue is unlimited.
At the start, the total number of shares (authorized capital) for a startup is typically kept low at 100 or 1,000,000, for example. However, not all shares of authorized capital should be issued.
You need to ensure that you have enough authorized stock in reserve to sufficiently issue shares to new investors or stakeholders. This is why you need to plan out your business’ capitalization structure from the beginning. A good balance is needed.
As a general rule of thumb, you should consider issuing around 50% of your shares when you are first incorporated. So if you have one partner, and authorize 1,000,000 shares, and issue 50% of them, each of you will have 250,000 shares each.
You can always increase the number and type of shares as you go, though it will mean legal fees for filing the paperwork.
What is your Startup Worth?
Unfortunately, as a brand new startup, your company will not yet have the track record, clientele, or experience of an established business. Because of this, the value of your shares will largely depend on the contributions you and your partners make when you incorporate a business.
Ideally, your business value is determined by what investors are willing to pay or contribute for it, or potentially buy it for. As such, you should work to come up with a value for the company through a startup valuation. This will help in determining a price for your shares.
How do you Calculate Shareholder Value?
Usually, shares in the startup have a fixed price, and investors buy into the company at that price. Ontario and Canada corporations, that is, companies that have gone through provincial or federal incorporation, are no longer permitted to issue par value shares, but a startup’s share value could be set at a low $0.01 per share to start (using our example above: 250,000 shares x $0.01 = $2,500).
Below are a few methods to help you come to a decision on the value of your startup shares:
Valuing your startup’s shares can also be determined by finding a public corporation similar in size and scope that sells similar products and services as your own. This allows you and your partners to estimate a comparative value for your own corporation using the Price-to-Earnings ratio of another corporation as a reference point.
Discounted Cash Flow
This is a method that forecasts how much cash flow your startup will produce overtime. While this method is not entirely reliable, it helps to make helpful assumptions about the expected rate of return on investment and the value of your company.
This method is exactly what it sounds like. You use a scorecard to measure and calculate a score on different criteria such as the Management Team, the Opportunity, Product, Competitive Market, Marketing/Sales Channels/Partnerships, and so on.
This is also called a shotgun clause, and is a common valuation method used should a shareholder wish to exit and leave the business. That shareholder will offer to buy the shares of the other shareholders, or sell the shares he or she owns to the others, for an agreed upon price. The other shareholders can either accept the offer or force the exiting shareholder to buy their shares at the price offered.
“Cost to Duplicate” Method
This startup valuation method uses existing records and receipts of expenses and costs. In other words, you are trying to find out how much it would cost to start a business like yours from scratch. It takes into account how much money has been put into it, though it does not include potential growth or intangible contributions like skills and knowledge.
Valuing the shares of your startup requires intense planning and thought. Also, note that each company is unique. Calculations from one method of valuation may work for one company, but not for another.
Needless to say, the entire process is complex. Ensure you have everything in place in order to issue shares to avoid any legal problems during the process. To fully explore, apply, or understand any of the above methods, consulting a securities lawyer is highly recommended from the start.