Set the Par Value for your Common Stock "Absurdly" Low
February 27, 2011 8 Comments
There are an increasing number of states that do not require you to set a Par Value on your stock, but assuming you are a Delaware Corporation, you will be advised to set a par value to minimize your potential Delaware Franchise Taxes (if you are not advised of this by your attorney, get a different attorney).
Par value for stock is an archaic concept that can most easily be thought of as the actual value of the paper your stock certificate is printed on (assuming the corporation that issued the certificate has any money to pay you if you attempt to redeem said certificate). Par value is applied on a per share basis, so a $.01 par value would mean one share of stock is “worth” $.01. This is what will show up on your balance sheet as Paid in Capital. Any amount paid above par value to purchase shares will show up as well, generally as Additional Paid in Capital.
Bonds have a par value that is more understandable, and is often set at the price paid for the bond itself. The idea being that the bond is worth, or on par with, what you paid for it (yes, we know this is oversimplified, we’re equity folks, not debt folks).
In the old days, stocks were issued with a similar viewpoint to bonds where the shares had a value that you were paying for them, and a value below which the entity would not issue additional shares (think of it as an early form of anti-dilution protection).
These days, the only thing that par value really matters for is in calculating how much you have to pay for your founders stock, as, assuming you purchase your founders stock when you first form the corporation, you will take the number of shares received times the par value, and you will pay that into the company to buy your shares.
Suddenly par value kind of matters, doesn’t it?
Here is the rub. People do not think about par value, and way too many attorneys put together the formation documents for a corporation and use a default par value number without thinking about the implication this value will have for the specific case at hand. Worse still, many attorneys use $.01 as a default par value. You can ask them why they did this after the fact, and they will not have a credible answer for why. If they give you one, please send it to us so we can debunk it. The real answer is they were not thinking, $.01 seemed small enough, or the formation document they used as a template for yours had it in there, so they went with it.
That is not good enough. We’ll show you why below.
Lets do some simple math. You and your co-founder start a company and you think it would be cool to each own one million shares of stock. You are both short on cash but have agreed to write the beta software code for no money while working out of your apartment, so the business will need almost no cash in the near-term. You hire an attorney who puts together the formation documents and uses a default $.01 for the par value. You sign the documents and everything is ready to go, when the attorney tells you that you each need to write a check for $10,000 to the Company to purchase your shares (and start the tax clock on your stock). Whoops!
What if instead, and we have seen this happen, the attorney sets the par value at $.10 per share (why anyone would ever do this we cannot say, but it happens). Now you don’t need to pay $10,000 each, you need to pay $100,000 each, just to purchase your founders shares!! Or, put another way, you need to hire a new attorney and start over. The biggest number we have seen was $275,000 for one founder to purchase their founders shares. This was a convoluted situation in that the Company quickly raised a significant amount of capital so it was not possible for a “do over” and in the end the Company provided a loan to the founder to cover the amount (it was not the founders fault that it happened. We won’t point fingers, but the company changed corporate counsel soon after). In the end it worked out, but trust us, you do not want this to happen to you.
So, what if instead you told the attorney up front that you wanted to set the par value at $.0001 per share? In the example above where you and your co-founder each purchase 1 million shares, you’d each be paying $100 to buy your shares and get rolling. The only things that have changed here are that you have a lower cost basis on your shares (you should, you paid less for them, which is a good thing), and your Company received a total of $200 instead of $20,000. This has no impact on the “valuation” of your company as viewed by potential investors nor the future potential of your business.
Our default recommendation (Note: default recommendations can be dangerous!!) is to set the par value at $.0001 per share. It is a meaningless number these days, so set it at a level that truly makes it meaningless and avoid paying a lot of money for your founders shares in the process. Your attorney might argue this does not fairly value the business (values it too low). If they did the formation work correctly, in that you have signed nothing of value to the business prior to purchasing your stock (IP, prior works, software code, etc.), and you have not raised outside capital, the value of your business at this point should be pretty much zero, so feel free to debate the point with them, or get a different attorney.
It is worth noting that a good corporate attorney will be on top of this so you do not have to be. They can provide you with the details you need as in reality it is not a difficult process.
Quick Note: You might consider setting the par value at a level that will make it so you put in the amount of money you calculated the company will need to get things rolling. If this is a relatively small number it is not a bad idea, but the larger the number gets the more you should consider funding the business in a different way (loaning money or purchasing shares at a higher price after transferring value into the entity), and just stick with setting the par value very low. Again, ask your Company counsel (and tax accountant) for their input on this.