We’ve received a number of questions on Par Value since publishing this post, so wanted to provide a more detailed (but still short) explanation of Par Value as it pertains to stock and specifically as it relates to startup companies.
The first place to go for most definitions is Wikipedia, but in this case the information provided is limited, and overly broad in that it tries to encompass all equity situations. Unless you truly need to be an expert on the topic, in which case you can search the Internet and find bits of info at a number of sites, here are the key things you ought to know about Par Value for Common Stock and Preferred Stock.
Par Value for Common Stock:
- It is an archaic concept. In “olden” days, companies used to issue (sell) shares of common stock at Par Value, a price below which no other shares could be sold (by the company, secondary sales are a different matter). Back when securities markets were not well regulated, this approach was intended to protect the purchaser and provide a simple accounting method as the par value per share times the shares sold was equal to the amount raised, which appeared on the balance sheet as Paid in Capital or Contributed Capital.
- Using Par Value can be avoided, but likely should not be. Most states, including Delaware, allow you to form a corporation with “No Par Value” shares, meaning you do not need to assign a Par Value to the stock. It can make the accounting and paperwork a little easier, but we do not recommend going this route because there are potential tax implications (Delaware Franchise Tax for instance), and since Par Value has been used “forever”, most legal and accounting materials factor it in already so the idea it can make this stuff easier is debatable. Over time as “No Par Value” becomes more common we expect it will be better to take this approach, but our basic view here is that if it “ain’t broke, don’t fix it”, and Par Value may be archaic, but it ain’t broke.
- Par Value for Common Stock should be set VERY low. The only time Par Value really matters these days is when you issue the initial (ie Founders) stock in a company. In most cases the Founders will purchase their shares at Par Value. As a result, for a set number of shares, the cost of purchasing founders shares will be directly proportional to the Par Value per share. We have a post on Setting Par Value that is worth reading if you are putting together a new company and trying to figure out what to do with the Par Value.
Par Value for Preferred Stock is a little different and still matters (sort of):
- For Preferred financing rounds, the Par Value for a series of preferred stock is usually set at the price paid per share in the financing round. In this case, the par value is specific to a single series of preferred, so if you issue multiple series (ie Series A, Series B, Series GG, etc.) each will have a different par value (unless two rounds are completed at the same price per share).
- This only “sort of” matters because with venture-backed companies, the terms of the investment typically limit the number of shares that can be sold of the series of preferred to a number that is slightly higher than the number actually sold in the financing (the difference leaves room for warrants or a small sale of shares in the series later on, for instance to a debt provider or outside board member who wants to invest in the latest round when they join the board). As a result, without a Par Value floor in place, investors in that round would still be protected from the company selling a lot more of that series of stock at a discounted price because there is very little left to sell (not to mention the investors will typically have a number of rights that would prevent this from happening even if there were more shares available to sell).
- Par Value for Preferred Stock is usually the basis for things such as dividend calculations as well as liquidation preferences and anti-dilution protection. Again, it only “sort of” matters because most financing documents do not refer to Par Value when setting these terms, they simply refer to a price per share or dividend payable per share, which in most cases is calculated off of the price paid per share. As such, you really do not need to worry about the Par Value of the preferred stock, it will never be a term you negotiate on (as opposed to price per share and overall valuation, which we trust you will negotiate in earnest). In other words, you can pretty safely leave this to the lawyers (and we do not say that often….).
That’s it on Par Value. If you still have questions, think we missed any useful points, or (god forbid) got something wrong, please post a comment and let us know.
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I am a minority shareholder in a startup that is just starting to incorporate and get all the docs set up. I noticed in the articles that 7.5mm common shares were authorized at $.0001 and 2.5mm preferred were authorized at the same price. We have no investors lined up yet so why would they authorize the preferred and have it priced already? I would be a minority shareholder with no board seat. How can this be used against me?
Mike:
The simple fact that there are preferred shares authorized should not be an issue for you. In addition, the $.0001 “price” is the Par Value, this is not necessarily the price at which the Preferred Stock would be sold to an investor down the road. The key difference is Authorized versus Outstanding shares. Authorized shares are shares the Company has the ability to sell (or grant if an option), but until this happens these Authorized shares do not get included in a Cap Table when figuring out ownership positions. In other words, based on the information you provided it does not look like there is anything ‘funny’ going on. We would not generally authorize preferred shares until a financing is going to happen, but don’t see any issues with doing it early either – we just think it is cleaner to do it with a financing round so you only create as many ‘authorized’ shares as will actually be sold (and thereby become outstanding shares) in the financing round. Odds are that if the number of authorized shares is too high, the investors will require the company to reduce the authorized preferred shares to be in line with or close to the number actually being sold in the financing (whenever that financing happens).
let say i incorporate my start-up with a par value of .000001 and buy 10 millions of founder stock for $10 can i then change the par value later on. will this make a impact financing preferred stocks via “s.e.c reg D” sale for investor.
Trent – While you could go thru the process of changing par value later on, there is likely no reason you would do so. What we think you are asking is whether you can later sell the common stock to other people at a price higher than the Par Value. The answer is yes, and you do not need to change the Par Value to do so. None of this should have any impact if you later decide to sell preferred stock to investors as the par value of the common (assuming it is set appropriately low) will have no tangible impact on the preferred financing. Hopefully this helps but let us know if it does not fully cover your question.
can you please help here,is it safe to say that the par value for Preferred stock is generally the price(say $25,$100 etc.) and there is no other hidden meaning to it…
Preferred stock usually has a low par value so the par value should have no meaning to it. It is not typically set as the price actually paid for the stock as that would cause issues if there is a situation where the value drops below that price – usually this is handled using liquidation preferences, not par value.
This is an interesting post. Since many small companies in Nevada issue shares below par value all the time, is there any written statute in Nevada that states this can’t be done. Although par value is typically defined as the minimum value that you can sell shares if there is a stated value, I am also trying to find a statute in Nevada that states this is the case.
I can’t find one.
Thank you
It is legal to sell shares in the US below par value but there are not any good reasons for this that would be considered “legit”. If you are involved with a company where someone proposes doing this you should hire a very savvy attorney who understands this stuff to look into the situation and also hire an accountant who can do the same. Playing around with Par Values in this day and age would raise immediate red flags for us and should for you as well. Worth reading the definition of “Watered Stock” on Wikipedia to understand a bit more on this if you are interested > https://en.wikipedia.org/wiki/Watered_stock
Hello. I have a question on par value of preferred. Let’s say for a seed round, the par value was set at whatever the common par value was. Why is that?
Annie:
It is key to remember that in this day and age par value is relatively meaningless. Remember that Par Value really has nothing to do with the price per share paid in the seed round. Most preferred stock rounds (including seed rounds) are convertible instruments, meaning they can be converted to common stock in certain circumstances and are automatically converted in others. Having the Par Value be the same as it is for common makes sense when the conversion ratio is 1:1 as it matches the par value. Again, this is fairly meaningless so don’t spend a lot of time overthinking it (as long as you are following our recommendation on par value in this post).