When a company is looking to grow their market share, pay off debt, diversify into related industries, or expand into new territories, they may require capital to buy what they need or increase production. If the company is cash-strapped or simply would like to avoid draining cash reserves, they may consider issuing stocks to raise money. This is referred to as stock financing. Selling shares of stock is equivalent to selling of a percentage of the company’s profits.
Corporate issues of shares of stock to the general public is one way to raise funds and finance long-term corporate goals. Continue reading to learn all about the differences between stocks and shares and how to issue a stock of your corporation.
- 1 What you need to know about stocks
- 2 What are preferred stock?
- 3 Difference between stock versus shares
- 4 Requirements to issue stock
- 5 The role of Board of Directors
- 6 Shareholders and voting rights
- 7 How to issue a stock?
- 8 Finalize the transaction
- 9 Pros and cons of issuing stock
What you need to know about stocks
What Are Common Stock?
In the financial world, common stock is a security that is sometimes referred to as capital stock. It represents the standard vehicle for selling a share of ownership in a corporation. There are a number of different types of stock that can be sold, including value stocks that have a lower price and growth stocks that are intended to increase in value as the company’s earning grow. Investors look to buying common stock as a way to diversify their portfolio into different financial securities.
When common stock is issued and the company goes bankrupt, the common stockholders will be paid after all debts and preferred stock shares are settled. For this reason, common stock has some risks. But, in the long run, it is the common stock that typically outperforms preferred stock and bonds.
The price of a stock share is relative, but it is usually based on a proportional value of a company’s worth. At any given point in time, the stock only represents a percentage of change as related to the company’s market cap.
What are preferred stock?
Preferred stock is also an issuance of equity or ownership in a company. The difference that holders of preferred stock will have a higher claim to shareholder payments or dividends compared to common stockholders. Preferred stockholders have only a limited amount of voting rights when it comes to shareholder governance. But, if your company must be liquidated due to bankruptcy, the preferred shares of stock will have preference over asset claims.
Keep in mind that preferred stock will also yield greater returns when monthly or quarterly dividends are distributed. Investors choose preferred stock as a more stable investment, because it pays both equity and fixed dividends.
The terms ‘stocks‘ and ‘shares‘ have very little difference. You can almost think of stock as a plural form of these financial vehicles while a share would be a singular term. Stock is used more commonly to describe owning a financial portion of a company. When someone says they own shares, it is typically in reference to owning a finite portion of a company. Buyers will request that stockbrokers buy shares in a particular company versus buying stock (plural) in different companies.
A share is the smallest portion of a company’s stock offering. So, if your investors are to buy stock in your company they might purchase 100s of shares.
Requirements to issue stock
Articles of incorporation
Before you can issue stock, your company must be a corporate holding, and have the board of directors approval to issue stock. Articles of incorporation is similar to a corporate charter or a certificate of incorporation. These are formal, legal documents that must be filed before your company can issue stock. It must include specific information such as the firms name, address, service agent, and how much and the type of stock that will be issued.
Keep in mind that articles of incorporation are typically filed with your state’s Secretary of State. Articles of incorporation are also necessary before you can apply for business loans or set up a business bank account. These documents will give your company a legal identity, and it is also necessary for separating your personal assets and finances from the business.
Your articles of incorporation will also state your total amount of shares that are authorized to be sold. You will not need to issue all your authorized shares. Often, some shares are held back in case more corporate owners are added or as a bonus or incentive for current shareholders.
The role of Board of Directors
Once your company becomes incorporated, it must abide by established rules of governance as set up by your board of directors. Your board of directors should be knowledgeable about your company’s operations and finances. They have the job of making sure the company’s vision, mission, and values are upheld. They are also the ones that lookout for stockholders by holding corporate officers accountable.
There are two mechanisms that directors respond to: movements in your company’s stock prices and proxy voting by shareholders. Directors can be voted out if they are found to be misbehaving or is they are underperforming. In summary, your board of directors acts as checks and balances, protecting the investment of shareholders, and making sure the company abides by SEC regulations.
When you decide to publically trade shares of your company in the U.S., you must have a board of directors that include both outside and internal representation.
Shareholders have some rights once you start issuing stock. They have shareholder voting rights that give them power to make their views known to executive managers and directors. This will typically use their voting rights when it comes to significant matters such as mergers or acquisitions, issuing new securities, or making any major changes in how the company operates. For instance, if a company decides to close all brick-and-mortar stores and convert to a total e-commerce business model, shareholders would have the right to vote on this decision.
Often, shareholders will vote by proxy. This means they will mail in their vote response or allow a third party to cast the proxy vote. Annual corporate meetings are held to give shareholders the voting power for electing new directors. Public companies must publish a notice that informs stockholders when proxy materials have been uploaded to the internet or other means for them to obtain a package which would include voting instructions, and annual report, and a proxy card.
How to issue a stock?
Determine how much capital you need
The first step before you make a decision to issue stock is to consider how much capital you need to raise and how much of the business ownership or equity you are willing to relinquish. The decision to issue a large amount of stock must be balanced against how much your are willing to dilute your ownership. The more you dilute your ownership in the company, the less voting power you will have. Once you own less than 50% of the company, you no longer have majority control.
The more shares of your company you offer to investors, the more shareholders you will have to buy out in the future – if you decide to take ownership back. But, it may be worth it if the funds you raise by offering more stock in your corporation to the general public is spent in a productive way, such as buying another company where you will have majority interest.
To calculate the proceeds from a stock issuance you will need to know at what price and how many shares the company will be issuing. Multiply the number of shares offered by the share price to calculate your gross proceeds. Keep in mind that some of that income will be kept by the underwriters for their fee.
Here you will need to resort to your company’s articles of incorporation. Within that legal document there will be specific language to specify how many shares the company can issue to employees and investors. If that number falls short of what you need to raise enough capital, the Board of Directors can alter the charter to authorize additional shares. But, this will require the approval of the shareholder majority. Often, many shareholders will object to diluting the stock price by issuing more shares.
If your company is a startup, or you are not taking your company public, then you may be offering stock to deal in another partner or two. Here you will need to weigh the worth of these new business partnerships in relation to the total worth of your company. If you want to give a new investor a 15% stake in the company, realize that each shareholder will now have a reduced equity. Everyone may still own the same number of shares when new people are dealt in, those shares are simply diluted.
It is important to reiterate majority ownership. As a safety net, it is wise to keep at least 50% of the total shares for yourself. so you will always own 50% of the business.
Now that you’ve considered the amount of capital you desire to raise and how much equity in the company you are willing to give up, it’s time to determine the price per share or the share value. For instance, if you value the shares at $100 per share, and you issue 51 shares to yourself and 49 shares for investors, then you can potentially raise $4,900. Of course, this is not a realistic share offering, but it makes it clear how easy it is to determine the value of each share dependent on how much money you want to raise and how much of ownership you want to keep.
Serious investors will look at the following four basic elements of stock value or price indicators to determine if your company is a good investment when it comes to value per share:
Price-To-Book (P/B) Ratio represents the value of the company if it is torn up and sold today.
Price-To-Earnings (P/E) Ratio is when a stock goes up in price without significant earnings increases, the P/E ratio decides if it can stay up
Price-to-Earnings Growth (PEG) Ratio incorporates the historical growth rate of the company’s earnings as it compares to other companies
Dividend Yield shows how much profit you will get when you invest in the company’s stock
When you keep these type of investor metrics in mind, it will help you look closer at your corporate earnings, growth, and profit in determining the value of your stock issue.
Common shares are preferred shares are explained above. But, here is where you will decide which class of shares to be issued. It is important to consider the class of shares issued because this will determine shareholder voting rights and who receives company profits first. Those investors who hold common shares are allowed to participate in corporate profits and even the proceeds when assets are sold off or liquidated. But, this is only after all preferred shareholders have been properly compensated. Common shareholders will also have voting rights.
Preferred shareholders are given preference to money distributed from bankruptcy and from profits. Preferred stock will give shareholders more confidence in their investment because their investment is similar to a bond with a set dividend payouts and redemption price (if the compnay wants to buy back a portion of shares, these redeemable shares have a set price per share that the company agrees to pay).
The question here is what is the best mix of common and preferred shares to issue. It will depend on how much voting control you shareholders to have and how you want to control your corporation’s profits. It is best to consult with business lawyer or an account to calculate the best mix of common and preferred shares to issue.
Follow state and federal securities law
To protect the public from buying stocks that have their value based on false claims and unsubstantiated profits, the U.S. Securities and Exchange Commission (SEC) regulates the sale of any stocks sold in America, including those companies that are based overseas. Before selling stock on the stock exchange, you must file a registration statement that details information about the company and the securities you are offering, SEC will selectively review the merits of securities offerings to determine if the securities being offered are based on sound data that supports a good investment.
To ensure you are compliant with state and federal securites laws, it is advised to consult with an attorney before you issue stock. SEC laws are very detailed and highly complex. A lawyer can guide you through the legal technicalities of issuing stock, and ensure you are in compliance with any and all state and federal securities law.
A corporate lawyer is the best choice to handle everything from the formation of your corporation to the issuance of stock. These professions are familiar with the necessary documentation and legal guidelines that can protect your interests and the interests of your investors.
Draft a Stock Subscription Agreement.
Here is where you layout a detailed plan of everything associated with the issuance of stock certificates to shareholders and other transactions you will be completing. You certainly should have the assistance of an attorney since a stock subscription agreement is a legally binding contract also known as a “share purchase agreement”.. It will outline the date of your issuance, the price per share, the number of shares, payment methods, and the person designated as the subscriber.
This document will also explain the terms of sale since you are granting or selling the shares to an investor. The agreement also makes it your responsibility to deliver the shares to the person who is buying at the agreed upon purchase price. Make sure these document have all necessary signatures to ensure their legality.
Your lawyer may also advise you to include warranties to guarantee issuance and payment for the protection of both parties against a breach of contract. Some language found in warranty statements include statements that the stock is free and clear title without financial or legal liens, and statements that no legal claims have been filed between the two parties at the time of contract signing.
Finalize the transaction
Now that all the legal and corporate details of issuing of stock are complete, the final act is selling the shares and receiving the cash as outlined in the stock subscription agrrement. When the stock owner recieves a check for payment of the stock purchase, they must provide the share certificates to the new owner. It is up to you, the stock owner, if you want to accept some other asset other than cash for payment. This is called a “non-cash consideration”. Some business owners may benefit from exchanging stock certificates for new equipment instead of cash. This is not a typical stock transaction, and you should have a lawyer draw up the agreement if you decide to go this route.
Pros and cons of issuing stock
Issuing common or preferred stock is one of many ways for companies to raise money. But, the decision many not be the right move forward for all companies. It may be a better move over going deeper into debt with business loans or other financial avenues. Your company’s first or initial public offering (IPO) can be followed by subsequent offerings. Companies may consider issuing less stock during an IPO and raise more capital when future shares are offered to investors.
An alternative to issuing stock is to offer a profit pool to your employees as a long-term incentive plan. Company owners or executive managers will decide on a percentage of annual profits that will go into a financial pool for later distribution to employees. This type of profit sharing motivates employees to produce more so that the company has more profit.
While issuing stock is a great way to avoid more debt and attract investors, it will also dilute your ownership in the company and reduce the owner’s profits. The founding owner will have less control over the company because stock ownership will grant shareholders voting rights. There are also legal risks. The company must abide by all federal and state laws governing the issuing of stock. If these rules are broken, there is the potential for heavy fines.