Common questions covered here
How are stock and shares used by companies?
What do I need to know about stock corporations to understand equity compensation?
What is equity?

Fundamentals of Stock Corporations18 minutes, 36 links

In this section, we describe the basics of how stock and shares are used.

Those familiar with stock, stock corporations, public companies, and private companies can jump ahead to how those companies grant equity.

Kinds of companies

Definition A corporation is a company that is legally recognized as a single entity. The corporation itself, and not its owners, is obligated to repay debts and accountable under contracts and legal actions (that is, is a “legal person”). Most commonly, the term corporation is used to refer to a stock corporation (or joint-stock company)), which is a corporation where ownership is managed using stock. Non-stock corporations that do not issue stock exist as well, the most common being nonprofit organizations. (A few less common for-profit non-stock corporations also exist.)

In practice, people often use the word company to mean corporation.

Definition A C corporation (or C corp) is a type of stock corporation in the United States with certain federal tax treatment. It is the most prevalent kind of corporation. Most large, well-known American companies are C corporations. C corporations differ from S corporations and other business entities in several ways, including how income is taxed and who may own stock. C corporations have no limit on the number of shareholders allowed to own part of the company. They also allow other corporations, as well as partnerships, trusts, and other businesses, to own stock.

In practice, for a few reasons, these companies are usually formed in Delaware, so legalities of all this are defined in Delaware law. You can think of Delaware law as the primary “language” of U.S. corporate law. Incorporating a company in Delaware has evolved into a national standard for high-growth companies, regardless of where they are physically located.

🔸caution This Guide focuses specifically on C corporations and does not cover how equity compensation works in LLCs, S corporations, partnerships, or sole proprietorships. Both equity and compensation are handled in significantly different ways in each of these kinds of businesses.

Loosely, one way to think about companies is that they are simply a set of contracts, negotiated over time between the people who own and operate the company, and which are enforced by the government, that aligns the interests of everyone involved in creating things customers are willing to pay for. Key to these contracts is a way to precisely track ownership of the company; issuing stock is how companies often choose to do this.

🚧incomplete Mention how court cases are settled?

Stock and shares

Definition Stock ownership is often formalized on stock certificates, which are fancy pieces of paper that prove who owns the stock.

Sometimes you have stock but don’t have the physical certificate, as it may be held for you at a law office.

Some companies now manage their ownership through online services called ownership management platforms, such as Carta. If the company you work for uses an ownership management platform, you will be able to view your stock certificates and stock values online.

Younger companies may also choose to keep their stock uncertificated, which means your sole evidence of ownership is your contracts with the company, and your spot on the company’s cap table, without having a separate certificate for it.

Definition Outstanding shares refer to the total number of shares held by all shareholders. This number starts at an essentially arbitrary value (such as 10 million) when the company is created, and thereafter will increase as new shares are added (issued) and granted to people in exchange for money or services.

Outstanding shares may increase or decrease for other reasons too, such as stock splits and share buybacks, which we won’t get into here.

Later, we discuss several subtleties in how shares are counted.

🚧incomplete What is a good overview on stock splits and share buyback. Key resources?

Definition Any shareholder has a percentage ownership in the company, determined by dividing the number of shares they own by the number of outstanding shares. Although stock paperwork will always list numbers of shares, if share value is uncertain, percentage ownership is often a more meaningful number, particularly if you know or can estimate a likely valuation of the company. Even if the number of shares a person has is fixed, their percentage ownership will change over time as the outstanding shares change. Typically, this number is presented in percent or basis points (hundredths of a percent).

Public and private companies

Definition Public companies are corporations in which any member of the public can own stock. People can buy and sell the stock for cash on public stock exchanges. The value of a company’s shares is the value displayed in the stock market reports, so shareholders know how much their stock is worth.

Definition Most smaller companies, including all startups, are private companies with owners who control how those companies operate. Unlike a public company, where anyone is able to buy and sell stock, owners of a private company control who is able to buy and sell stock. There may be few or no transactions, or they may not be publicly known.

🚧incomplete What are public exchanges and how is stock bought and sold in practice? Mention accredited investors?

Governance

Definition A corporation has a board of directors, a group of people whose legal obligation is to oversee the company and ensure it serves the best interests of the shareholders. Public companies are legally obligated to have a board of directors, while private companies often elect to have one. The board typically consists of inside directors, such as the CEO, one or two founders, or executives employed by the company, and outside directors, who are not involved in the day-to-day workings of the company. These board members are elected individuals who have legal, corporate governance rights and duties when it comes to voting on key company decisions. A board member is said to have a board seat at the company.

Boards of directors range from 3 to 31 members, with an average size of 9. Boards are almost always an odd number in order to avoid tie votes. It’s worth noting that that state of California requires public companies to have at least one woman on their boards.

Key decisions of the board are made formally in board meetings or in writing (called written consent). Many decisions around granting equity to employees are approved by the board of directors.

🚧incomplete This section could be expanded, and also include more legal links.

IPOs

Definition A private company becomes a public company in a process called an initial public offering (IPO). Historically, only private companies with a strong track record of years of growth have considered themselves ready to take this significant step. The IPO has pros and cons that include exchanging a host of high regulatory costs for the benefits of significant capital. After a company “IPOs” or “goes public," investors and the general public can buy stock, and existing shareholders can sell their stock far more easily than when the company was private.

Companies take years to IPO after being formed. The median time between a company’s founding and its IPO has been increasing. According to a Harvard report, companies that went public in 2016 took 7.7 years to do so, compared to 3.1 years for companies that went public in 1996.

🚧incomplete What are the restrictions and regulations on selling stock that affect employees at IPO? What is a lockup period?

Sales and liquidity

❗️danger️ With private companies, it can be very hard to know the value of equity. Because the value of private company stock is not determined by regular trades on public markets, shareholders can only make educated guesses about the likely future value, at a time when they will be able to sell stock.

After all, private company stock is simply a legal agreement that entitles you to something of highly uncertain value, and could well be worthless in the future, or highly valuable, depending on the fate of the company.

☝️confusion We’ll discuss the notion of a company officially assigning a fair market value later, but even if a company gives you a value for your stock for tax and accounting purposes, it doesn’t mean you can expect to sell it for that value!

Definition An acquisition is the purchase of more than 50% of the shares of one company (the acquired company) by another company (the purchaser). This is also called a sale of the acquired company. In an acquisition, the acquired company cedes control to the purchaser.

Definition The ability to buy and sell stock is called liquidity. In startups and many private companies, it is often hard to sell stock until the company is sold or goes public, so there is little or no liquidity for shareholders until those events occur. Thus, sales and IPOs are called both exits and liquidity events. Sales, dissolutions, and bankruptcy are all called liquidations.

Often people wish they could sell stock in a private company, because they would prefer having the cash. This is only possible occasionally. We get into the details later, in our section on selling private stock.

Definition A dividend is a distribution of a company’s profit to shareholders, authorized by the board of directors. Established public companies and some private companies pay dividends, but this is rare among startups and companies focused on rapid growth, since they often wish to re-invest their profits into expanding the business, rather than paying that money back to shareholders. Amazon, for example, has never paid dividends.

You’re reading an excerpt from a Holloway Guide.
The Holloway Guide to Equity Compensation
Joshua Levy, Joe Wallin, and over 35 contributors
Over 3 hours and 300 linked resources

Stock options, RSUs, job offers, and taxes—a detailed reference, including hundreds of resources, explained from the ground up and made to be improved over time.