Key Takeaways

  • Private companies can issue shares to raise capital without going public.
  • The process involves legal, regulatory, and documentation requirements.
  • Companies must determine authorized shares and update corporate records.
  • Issuing shares requires compliance with securities exemptions.
  • Small businesses can issue stock, but they often need to amend articles of incorporation and consult legal experts.
  • Share issuance types include common vs. preferred shares and new vs. existing shares.
  • Shareholder agreements, valuation, and cap tables are essential elements of the process.
  • Equity management tools can streamline the share issuance process.

If you're wondering how to issue shares in a corporation, you're probably thinking about a company issuing shares as a way to gain the necessary capital for business endeavors or expansion. Shareholders of public companies must approve this move beforehand, and there are a number of steps and limitations that must be considered before proceeding.

Procedure For Issuing Shares

The procedure for issuing shares includes:

  • Creating a prospectus.
  • Submitting the application of shares.
  • Completing the allotment of shares.
  • Issuing the call on shares.

The first step is developing a prospectus, which is a document that publicly invites potential investors to buy shares in the company. Before the document is published, a copy must be submitted to the Securities and Exchange Commission. If a business operates as a private company or privately issues shares, it does not need to draft a prospectus. The information within the prospectus includes information regarding the company's management, activity up to that date, details regarding the need for issuing shares, and other relevant information for a potential investor.

The application of shares is a form used by potential investors to submit their intention to buy shares in that company. If the number of issued shares is lower than that of requested shares, an oversubscription occurs. If, on the other hand, there are more shares than requested, it is called an under-subscription. The applications are issued to a designated bank, and the funds are only transferred when the procedure is complete.

The allotment of shares is when the issuing company selects the applicants that will be given the right to purchase the issued shares. The selected investors are notified through an allotment letter specifying the deadline for paying the price for the shares. Not all applicants will have successful bids, and those who are not accepted do not receive allotment letters. They also get back the application fee.

After the application and allotment phases, a call on shares is issued in order to collect any remaining shares. The number of calls depends on the number of installments, and the call amount should not be larger than the share's nominal value.

Why Private Companies Issue Shares

Private companies issue shares for several reasons:

  • Raising Capital: To fund growth, development, or operations without incurring debt.
  • Attracting Talent: Issuing equity compensation (e.g., stock options or restricted stock) helps attract and retain top employees.
  • Investor Relationships: Shares can be used to formalize partnerships with early investors or venture capital firms.
  • Restructuring Ownership: To bring in co-founders, reward early contributors, or realign shareholding structures.

Issuing shares strategically allows companies to grow while preserving control and financial stability.

Common Challenges in Issuing Private Shares

Private companies face several common challenges when issuing shares:

  • Valuation Disputes: Investors may question the company's valuation, affecting their willingness to invest.
  • Dilution Concerns: Existing shareholders may be concerned about losing influence if too many new shares are issued.
  • Compliance Risks: Failure to follow securities laws can result in fines or regulatory scrutiny.
  • Lack of Liquidity: Investors often seek liquidity options, but private shares are not easily sold or traded.
  • Recordkeeping Errors: Inaccurate cap tables or incomplete documentation can cause future disputes or legal complications.

To avoid these pitfalls, companies often use legal counsel and equity management tools.

Steps for Issuing Shares in a Private Limited Company

The steps for issuing shares in a private limited company include:

  1. Check Articles of Incorporation: Ensure the company has the authority to issue the desired number of shares.
  2. Conduct a Shareholder or Board Meeting: Obtain formal approval through a board resolution.
  3. Determine Share Value: Use a 409A valuation or similar method to establish fair market value.
  4. Draft and Sign Shareholder Agreements: Include terms such as transfer restrictions, vesting schedules, and rights of first refusal.
  5. Issue Share Certificates or Digital Records: Deliver proof of ownership to the shareholder, whether in physical or electronic form.
  6. Update Company Records and Cap Table: Record the transaction in your stock ledger and update the ownership structure.
  7. File With the State (If Required): Depending on your jurisdiction, you may need to file an amended certificate of incorporation.

Types of Shares That Can Be Issued

Private companies typically issue one or more of the following types of shares:

  • Common Shares: Represent ownership in the company and voting rights, usually issued to founders and employees.
  • Preferred Shares: Offer advantages like dividends or liquidation preferences and are often issued to investors.
  • Voting vs. Non-Voting Shares: Some companies differentiate classes of shares based on voting power, which allows raising capital without diluting control.
  • Restricted Shares: These are subject to vesting schedules or resale restrictions, common in employee stock compensation plans.

Clearly defining the class and terms of each type of share in corporate bylaws or shareholder agreements is crucial to avoid future conflicts.

Key Considerations When Issuing Shares in a Private Company

Issuing shares in a private company involves several strategic, legal, and procedural considerations to ensure compliance and accurate representation of ownership. These include:

  • Authorized Share Capital: Confirm the number of authorized shares in your articles of incorporation. If more shares are needed, you’ll have to file an amendment.
  • Board Approval: Share issuance typically requires approval from the board of directors via a resolution.
  • Shareholder Agreements: If the company has existing shareholders, their rights and any pre-emptive rights must be reviewed to avoid dilution disputes.
  • Valuation: Determine a fair market value for the shares. This is especially critical for startups offering equity to employees or investors.
  • Securities Law Compliance: Shares must be issued in compliance with SEC exemptions (e.g., Regulation D Rule 506) and possibly state “blue sky” laws.
  • Cap Table Updates: Maintain an updated capitalization table to track ownership changes, dilution, and valuation over time.
  • Stock Certificates or Digital Records: Issue share certificates or register ownership digitally using equity management platforms.

Issuing Stock as an S Corporation

Although S corporations can issue shares, the Internal Revenue Service has many restrictive rules and regulations that make S corporations an ineffective investment for some potential buyers. These restrictions must be well known by company founders so they can properly decide on what type of entity they want their business to be.

S corporations can only issue one type of stock, meaning it cannot issue one class of stock where investors receive dividends and another where they don't. The only exception the IRS makes to that rule is differentiating the stock by voting rights, meaning that issuing a class of stock with voting options and another without voting options is permitted. This is often used by family-owned companies when the stockholders want to transfer some of the stock to their heirs in order to lower the estate tax but do not want to also share control of the company.

Another limit imposed on S corporations is the maximum number of shareholders, which cannot be larger than 100. This rule also has an exception, as family members owning shares are counted as one person. People with at least one common ancestor within the past six generations, as well as the common ancestor's spouse or prior spouse, are considered family members. That way, an entire family, containing parents, children, grandchildren, and their children and grandchildren's spouses, is counted as one shareholder.

If any of those restrictions imposed by the IRS are violated, then an S corporation would lose its status and becomes a C corporation. The main difference is that with a C corp, the losses and gains are no longer directly attributed to the shareholders, and the business must pay corporate income tax. Any funds taken out of the company are counted as dividends.

Things become significantly more simple and straightforward when the corporation only has one investor. In this situation, the sole owner has the flexibility to control the company's size and share value according to his or her needs.

Frequently Asked Questions

  1. Can a private company issue shares to the public?
    No. Private companies cannot issue shares to the public without registering with the SEC. They can, however, issue shares privately under securities exemptions.
  2. Do private companies need to file with the SEC when issuing shares?
    Not always. Most private offerings qualify for exemptions like Regulation D, which allows them to avoid full SEC registration while still requiring filings such as Form D.
  3. How do I determine the value of shares in a private company?
    You can hire a third-party valuation firm or use methods such as a 409A valuation to establish fair market value, especially if offering equity to employees.
  4. Is board approval necessary for issuing shares in a private company?
    Yes, in most cases the board of directors must approve the issuance of new shares, often documented in board meeting minutes or a resolution.
  5. Can small businesses issue stock?
    Yes, small businesses structured as corporations can issue stock, but they may need to amend their formation documents and should consult legal counsel to ensure compliance.

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