Silicon Valley Legal Bible（3）Why are there so many shares in startups?

The Silicon Valley Legal Bible with Forty-Two Chapters, a legal encyclopedia customized for founders. I am Xiaoxiao Liu, a U.S. attorney.

Founders often see lawyers start their companies with 10,000,000 initial shares, and the question that arises is why do startups need so many shares, and isn't 100 shares enough? Another question is, if 10,000,000 shares are okay, why not 1,000,000,000 shares?

I. Why can't the shares of a startup company be smaller, and is 100 shares not enough?

1. Shares must be a natural number

Before answering this question, it is important to understand that there can be no decimals or fractions in the shares, and we know that shares cannot be negative, so in fact, they must be natural numbers. So it can be seen that although 100 shares can meet the founder of the three-seven, two-eight, that is, 30 shares / 70 shares, and 20 shares / 80 shares, but a little bit of so a round of financing will not work, such as an investor's shares is 19.8%, another 20.2%, because the shares must be a natural number, rounded up, are 20 shares, no difference.

Also when it comes to employee options is even worse, because employee options are usually accounted for zero percent, or even zero point zero, then for all the 0.1%, 0.2%, 0.3%, 0.4% of the shares, are rounded up to 0, not to mention those 0.01%, 0.02%, 0.03%, 0.04% of the shares, are brushed to zero.

2. Psychology of share prices

Another issue to consider is the effect of share price on the psychology of the buyer. Imagine the same $10,000, if you tell the buyer that this is 1 share, each share is worth $10,000, or that this is 10,000 shares, each share $1. The former makes people feel that they are spending a lot of money to buy very little, while the latter makes people feel that they are buying something very cheap. So from this point of view, we can also see that for the shares of a company that needs to be publicly traded in the future, it will be better to sell the shares at a cheaper price if the number of shares is higher.

For example, for example, the following is the world's most expensive 10 stocks, we can see that the 2nd -10th are a few thousand dollars a share (which not a few of us all know the Mexican fast food Chipotle), and ranked at the top of the list of Berkshire Hathaway a share of more than 500,000 U.S. dollars, which can be in the central part of the U.S. to buy a set of houses. Berkshire Hathaway is actually Warren Buffett's company. From 1980, Berkshire Hathaway's stock is almost 300 dollars a share, and then after four or five decades, inflation, the stock market rose and the company's own development is booming, Berkshire Hathaway's stock is more and more expensive, but Warren Buffett has never given it to crack the stock. In fact, like the market value than Berkshire Hathaway higher than a few technology giants, Apple, Google, Amazon and so on in fact, if not crack shares, the stock price will be high to the point that ordinary people can not afford to buy, but they all chose to crack the stock, so that the stock price does not seem to be so outrageous, but also to make the majority of the shareholders easier to invest in their companies.

So we should find that whether it is a share of $500,000 Berkshire Hathaway, or a share of a few thousand dollars in the table of those companies, is not it all prohibitive to our general public? There is a share of a few tens of dollars, a couple of hundred dollars of company stock can buy, I think the big not everyone want to buy a share of a few thousand or even hundreds of thousands of dollars of stock. So why don't these companies with very high unit prices crack shares? Warren Buffett said that he hoped to buy his company's shares of people are after careful thought of the intention of long-term holdings, rather than a few hours or a few days to buy and sell speculation short-term. And for newly listed stocks, they all want to be more actively traded, making the price per share seem lower and lowering the barrier to purchase, then naturally more people will be willing to buy.

Second, why can't start-up companies have more shares? Can't we have 10 billion or even 100 billion shares?

Many people say that the shares of the startup company is the end of the line, but very few people say why the shares of the startup company can not be more, to 10 billion shares or even 100 billion shares can not hurt, is not just a few more zeros? But why doesn't anyone do that? Why do we need 10 million shares?

The reason is that when your company goes public, JPMorgan, Goldman Sachs and other investment banks want your company to be valued at $1b (one billion dollars), to maintain almost $10 per share, we do the math is not right ah, $1b (one billion dollars) per share of $10, then it should be one hundred million shares, not ten million shares? That's because the company in the beginning when the shares are 10 million, but then with each round of financing and employee option pool shares will be more and more, you can see most of the companies listed on the New York Stock Exchange or NASDAQ in the U.S. are basically financing a ten times eight times to go public, the initial shares have long been diluted to a mess.

Here I also listed all the companies listed in the U.S. in 2022, you will find that indeed most of the companies listed on the day of the opening price is basically $ 10 a share.

Again, why $10 instead of $100 or $1? The reason it can't be $100 is actually the same stock price psychology as above, when the price per share is too expensive, it discourages people from buying, and now that the hottest tech giants have just over a hundred dollars a share, it's obvious that the new offering doesn't want to set the price too high.

But at this point, some people ask why it can't be $1 since the cheaper it is, the more it encourages people to buy. This is actually because of the American Stock Exchange's $1 delisting rule, which requires a company to be delisted if its closing price stays below $1 for 30 trading days. So companies don't want their company stock to be struggling with the life and death of delisting when they first go public, at least.

The Silicon Valley Legal Bible with Forty-Two Chapters, a legal encyclopedia customized for founders. I'm U.S. attorney Liu Xiaoxiao, and we'll see you in the next installment.