What is Business Capitalization?

Capitalization is the funding of the business venture. A startup will be capitalized by contributions from founders. In exchange for contributed value (funds or assets) the founders will receive shares of the corporation.

Capitalization also refers to the value of the outstanding shares. As such, the calculation of outstanding shares is relevant to determining the percentage of ownership. As mentioned a separate lecture, the number of outstanding shares may be calculated as:

• issued shares only;
• issued and outstanding shares that include all options, warrants, and convertible instruments that could convert into common shares (the "fully diluted" measure); or
• authorized shares taking into consideration the possible options, warrants, and conversions; but, also estimating a certain number of forfeiture of shares and buy-backs by the company.

Ownership percentage is calculated based upon common shares. Each measure will affect the ownership percentage of a holder of common shares. The calculation gets a bit more complicated when calculating in whether options to purchase for shares have vested or no. Non-vested shares are still subject to forfeiture. Calculating the fully-diluted shares thus makes assumptions about the vesting (and forfeiture) of shares.

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What are the steps in business capitalization?
 

The corporation should follow the following steps regarding capitalization:

• Subscription Letter
• Subscription Agreement
• Stock Certificate
• 83(b) Election
• Securities Filings
• Stock Option Plans
• Buy-Sell Agreement
• Consent to Service

What is a Subscription Letter?

A subscription letter acknowledges a prospective shareholder's intention to purchase equity in the newly-formed company. 
 

What is a Subscription Agreement?

A subscription agreement (or stock-purchase agreement) is the agreement entered into by founders of the corporation to purchase shares of the corporation in exchange for a given amount of value. The subscription agreement will lay out the specific types of shares purchased and the rights of the holder of those shares. It may also place additional restrictions on the shares and establish a period of time over which ownership of the shares vest in the purchaser.

• Note: A subscription agreement may have appendices containing additional information, including the company's capitalization table and the stock ledger documentation corporate ownership.

What is a Stock Certificate?

The board generally issue Stock Certificates and Receipts for the purchasers of shares. The stock certificates represent a share of stock of the corporation. Some corporations do not issue stock certificates; instead, these corporations send out notices of Issuance of Uncertified Common Stock.

What is an 83(b) Election?

The board may prepare of Memorandum regarding the 83(b) Elections by the founding shareholders. The 83(b) election must be made at the time of issuance. This election locks in the tax basis of the stock at the time of issues. This is important for equity that vests over a period of time and may significantly increase in value by the time it vests. It will avoid an unfortunate tax situation.

What are Securities Filings?

Prepare and File Federal and State securities filings for stock issuances to shareholders (Founders)

• Note: See our Securities law lecture series for more information on the federal and state requirements for securities filings.
   

What are Stock Issuance & Option Plans?

Prepare Stock Option/Stock Issuance Plan & Agreement & Stock Option Agreement or Early Exercise Stock Option Agreement

What are Buy-Sell Agreements?

The corporation will want to ensure that the companies shares are not transferred to third parties except under the circumstances approved by the corporation. The buy-sell agreement may provide any number of rights to the corporation, such as the right of first refusal to purchase shares.

• Note: A well-drafted buy-sell agreement is incredibly important. It can, however, by complex. It is a good idea to seek professional assistance from an attorney skilled in drafting buy-sell agreements.

What is a Consent to Service?

Prepare and file Form U-2 Uniform Consent to Service of Process (in connection with securities filings).

What is a Capitalization Table?

Any investment calculation will be represented in a capitalization table or (Cap Table) that lays out the outstanding shares and those to be awarded in the transaction. The Cap Table will indicate the category of equity ownership (common shares, preferred shares, warrants, options, convertible debt). The Cap Table will also account for the pool of shares typically set aside for use as compensation for managers of the firm. Option pools are discussed in a separate lecture. Read more about Cap Tables...