published January 27, 2021
As with anything that isn’t absolutely mission critical to the functioning of your new company, you may be tempted to delay pricing your shares until a later date. Our advice? Don’t give in to that temptation.
When you first set up your company, it behooves you to set a value for your company’s shares to avoid issues down the line. This value is called a par value. It is possible to issue what are called no par value shares in many states (including Delaware) but it is not usually done for a multitude of reasons.
Founders typically use the par value as a price when purchasing their founders shares shortly after incorporating the company. In the typical compensation package for a startup, later shares issued to advisors and employees are generally offered to employees at what is known as fair market value (FMV).
What is Par Value?
Par value, also called "face value" or "nominal value," is the lowest legal price for which a corporation may sell its shares, and is typically set between a fraction of a cent (the lower range is known as a low par value) and a few dollars. This has little to nothing to do with how much a corporation’s shares are actually worth or sold for.
Instead, it is a somewhat outdated legal and accounting concept mandated in the corporate law of some states. In these states, when a corporation is formed, the articles of incorporation must define a minimum price—or par value—for the company’s stock.
Everyone who buys shares in the corporation, including the corporation’s founders, must pay at least this amount.
The term par value can be confusing because it has nothing to do with the price investors pay to own shares in the company. For example, you can establish a par value of $0.0001 per share but sell shares to investors for $10 per share.
Issuing “No-Par Value” Shares
While it is legal in some states including Delaware to issue no par value shares at a company’s outset, it is not often done. While it might seem like a good idea to issue no par value stock to avoid tax liability and issues surrounding taxation and early valuation, issuing stock at no par value means the corporation will be unable to use the Alternative Method, potentially incurring increased tax liability at the end of the year.
Instead, it will be forced to calculate tax liability using the Authorized Shares Method, which often results in a much higher tax burden—especially for early stage companies.
Establishing Par Value of Corporate Stock
It is up to the incorporators to decide what the par value of the corporate stock will be. Typically, new companies will establish a low par value such as one cent or a fraction of one cent per share. This way they can issue many shares without the founders and other early shareholders having to pay a large price to acquire their shares.
Typically, at the time of incorporation, a company will not have many (or any) assets or intellectual property to its name. For this reason, a very low par value, like $0.00001 per share, is generally considered reasonable.
FMV vs Par Value When Purchasing Shares
Par value is a very different concept from fair market value (or FMV). For tax and other purposes, the broadest sense of Fair Market Value is simply the price a willing buyer is prepared to pay for and a willing seller is prepared to sell a given item—in this case, shares in a private company. This includes the FMV of stock at the time when a company grants stock options or other equity compensation.
Under federal tax laws, if you purchase shares for a price equal to their fair market value, then you will incur zero additional tax obligations at the time of purchase. Because a startup’s shares can quickly increase in value as the company develops its product and increases capitalization through customer revenue or raising funds from investors, it is important for founders to issue and purchase their shares at the time of the company’s formation,
At that time the fair market value of the shares—and the purchase price that is paid—is almost zero since the company’s only real assets are the ideas of the founders forming the company.
If the founder (or any shareholder) purchases shares for a price lower than the fair market value of the shares, they could potentially be subject to a tax known as the Alternative Minimum Tax.
For example, If I were to buy 100,000 shares in a company for $1 per share, and the fair market value of these shares is $11 per share, I would potentially be responsible for paying federal taxes on the $1 million difference between the fair market value of the 100,000 shares and the price I paid for these shares.
After you purchase your shares, you are required by law to file an 83 (b) election to notify the IRS of your stock purchase within 30 days. Read more about in the article Why You Should File Your Section 83 (b) Election.
Updating the Company’s Valuation Over Time
Companies typically offer stock grants and options at the fair market value price of the company’s shares. Failure to do so, and undervaluing these options, can result in major IRS penalties and lost compensation.
While the initial fair market value of a company’s shares may be set internally, as companies mature, they typically turn to outside appraisers to establish a fair market value for their shares. These appraisal firms independently research and determine a fair market value price for the company’s common stock in a process called a 409a valuation.
Companies typically complete a 409a valuation every 12 months or after each fundraising round. We’ll cover the 409a in further depth in a future article. Until then, start pricing.
- Setting a value for your stock now rather than later is generally preferable.
- “Par value” or “face value” is the lowest price for which a company can sell stock.
- “Fair Market Value” is the notional value of stock on the market at the time of sale.
- A reasonable par value for an early stage company can be as low as $0.00001.
- Setting a par value low can avoid tax liabilities later.
- Companies update their value over time using external valuation firms, but set it internally at the outset.
Most founders have little clue about how cap tables work when they start their first startup. Keeping accurate records of your cap table is essential for startup founders if they plan on raising capital from VCs or selling the company.
409A valuations are independent appraisals of a startup's common stock. Startups should use an independent, outside valuation firm to get a 409A valuation before offering stock options to employees to avoid fines and legal issues with the IRS.
Startups typically issue common shares to founders, employees, advisors and consultants; they issue preferred shares to investors as part of venture financing rounds The preferred class of stock in a startup is typically subdivided into series, each representing a different round of financing, like Series A, Series B, and so on.