A common question for those forming companies is how to deal with par value, which is understandable because it often does not bear a relationship to the actual value of the shares. Par value in most states, including Delaware, is a relic of their corporate statutes that typically comes into play in calculating franchise taxes and for lawyers giving legal opinions, and thankfully once set appropriately will never need to be dealt with again. So how does a start-up set it appropriately?
Like many states, in Delaware stock is ordinarily issued with a nominal par value (the Goodwin Procter Founder’s Workbench Document Driver uses $0.000001 per share) or no par value.
Delaware’s franchise taxes are calculated either using the “authorized shares method,” which assigns a set value to each share, or the “assumed par value capital method,” which takes into account the corporation’s assets. Issuing stock with no par value is tempting at first since, assuming the corporation has no value at the outset, there is no need to pay the corporation the par value for the stock when forming the corporation.
In addition, as long as there is only a modest number of shares authorized, the Delaware franchise taxes will also be reasonable by using the authorized shares method: for instance, for 5,000 authorized shares or less, the tax is $75. The trap for the unwary is that if there is no par value, one must use the authorized shares method and, when a corporation grows and increases the number of authorized shares, the authorized share method often results in a far greater franchise tax bill: for instance, if a corporation has 15 million authorized shares, which is not at all uncommon after an initial round of financing, the annual tax bill is $112,575!
By comparison, that same Delaware corporation using a low par value of $0.000001 per share and the assumed par value method, with 15 million authorized shares, of which 5 million shares have been issued and with gross assets of $500,000, would have an annual tax bill of $700. Of course, the drawback to setting a par value is that when shares are initially issued at formation, founders must pay the corporation at least the par value per share, but this is a small price to pay to avoid a potentially large franchise tax bill in the future.
The Delaware Secretary of State’s website, which includes a special calculator, is fantastic at explaining the above and is worth a look before setting up a corporation.
This post on Tax, and Start-up Issues was authored by Ryan Sansom.