If you’ve decided to issue shares in your corporation, here are the steps you need to take to make sure you do it right. This way, you’ll be able to raise capital for your new business projects!
Issuing shares is a process that can be filled with lots of potential pitfalls, especially if it’s your first time to do this. It’s not really a simple task at all.
But then again, it may be worth the risk, as it’s a good alternative to asking a loan from a bank. You can raise more working capital to help your business grow and become even more successful than it is now.
You have to do it right. Here are the factors you need to consider and the steps you need to take, so that issuing shares can actually help your business. If you do it wrong, things can go a lot worse!
Questions to Ponder First
Let’s say that you’ve just recently incorporated your business. Now, you’ve decided on issuing shares to raise capital, so you can fund more of your new ideas.
But before you can sell these shares, you first need to find the answers to the following crucial questions:
How Much Capital Do You Need to Raise?
One of the main issues with bank loans is that, more often than not, the lender decides how much money they will lend you. That’s only right, since it is their money, after all.
But since it’s your company, you also get to decide how much money you want to gain from shares in your company. This number can’t be set arbitrarily. It has to make sense so that you can convince investors to buy your offered shares. It’s best if you have a specific goal in mind for this new capital so that your investors have a better idea of how you’re planning to grow your corporation.
How Many Shares Should You Issue?
It’s possible that your company’s articles of incorporation already list the number of shares in your company. But that number isn’t set in stone. You can just change the number of shares, and then you can file an amendment to your articles of incorporation. This amendment involves a fee, but it’s quite minimal.
The simplest scenario here is that you have as many shares as you have shareholders. But that can prove complicated when some people want to buy multiple shares and a larger piece of the pie. Or if an individual wants to sell have the value of their share, it’s obviously more convenient if they have 2 shares rather than a single one.
Keep in mind also that having multiple shareholders will affect their voting rights. With fewer shares available, each share has a much larger voting impact. That increases the value of the shares.
What Is the Value of Each Share?
Theoretically, all you need to do here to determine this value is to get the amount of capital you wish to raise, and then divide it by the number of shares you plan to issue. So, if you want an extra half a million dollars and you plan to issue 5,000 shares, then you can set the value of each share at $100 apiece.
One of the more sensible options is to first determine the value of your business accurately. This way, potential investors have a clearer idea of how much they ought to invest in your company.
You can’t overvalue your business, because that can lead to charges that you’re trying to deceive investors as to how much your business is really worth. That can certainly ruin your reputation.
At the same time, there’s a risk when you set the price too low for each share. The price may be low enough that another investor can come in and gobble a large chunk of the shares. They may even gain a majority of the shares, and end up with a lot of control over your own company. Depending on the shareholders’ agreement, this investor may end up having a controlling voice as to the membership into your board of directors.
Will Your Corporation be Public or Private?
Both public and private corporations can issue stock, but there are certain important differences.
With a public corporation, you can trade your stocks on the stock market. You’re allowed virtually unlimited number of shares to issue. Theoretically, that means you can raise practically any amount of funds from your public investors. This is the main reason why so many prominent companies go public with their shares.
The accompanying red tape can be rather troublesome, however. The SEC sets stringent standards regarding what you’re required to disclose to your public shareholders. You need to be quite transparent regarding the financial state of your corporation. You have to be very clear about what financial risks your potential investors may face.
Private corporations can only sell shares to the owners and founders of the company, and to private investors. Consequently, private corporations can’t issue as many shares as public corporations. The shares aren’t available in the stock market, which does limit your access to investor funds.
The main advantage of remaining private is that you don’t have to register your company with the SEC. You don’t have to disclose info regarding your company’s financial state to the general public either. The public can’t buy into your shares, so they really don’t have to know.
Without the SEC red tape, running your business is a lot easier (and certainly less of a hassle). You may want to consider remaining private, if you think you’ll find it difficult to meet the SEC standards.
What Type of Stock Do You Want to Offer?
You’re probably running a C corporation, which is the standard corporation under the IRS regulations. In that case, you can issue several types of stock.
But if you’re running an S corporation with a special tax status with the IRS, you can only have a single type of stock to offer.
The two main types of stock are the common stock and the preferred stock. There are other types of stock you can offer, but in general these 2 types are generally the most popular. You do have different sets of pros and cons for each type.
Generally, with common stocks, you offer voting rights with the shares. That means the investors have a voice regarding the election of board members.
Also, this type entails the most risk for investors, but it also offers higher potential returns.
Preferred stock usually doesn’t come with voting rights. But on the other hand, the investors with preferred shares usually receive a fixed dividend instead. This is in contrast to common stocks, which offer non-guaranteed variable dividends.
In the case of liquidation, shareholders of preferred stock are also paid off first before the common stock shareholders.
The Shareholder’s Agreement
When the shareholders get their stock, their money also gives them certain rights and privileges as well. These rights and privileges are all spelled out in the shareholder’s agreement. This is a contract between your corporation and the investors who bought shares in your stock.
Just because someone owns shares in your corporation doesn’t mean that they have unlimited ownership privileges regarding your company assets. This is patently absurd. It’s as if you bought several Apple shares, and you think you can march down to any Apple store and get iPhones and iPads for free.
This is why you need to come up with the shareholder’s agreement. This contract spells out all the important details pertaining to your stock.
- It can clarify the voting procedures and voting rights.
- It can explain the rights to dividends for shareholders.
- It can specify the control of the shareholders over the board of directors.
- It can stipulate when new shares can be created, and how they can be transferred.
- It can set conditions on when and how new shareholders can buy shares.
A good shareholders’ agreement protects both parties. This should prevent your shareholders from wresting control of the corporation from you. At the same time, your shareholders’ have rights set on a firm contract.
SEC Registration for Public Corporations
If you decide to have a public corporation, you’re required to register with the Securities and Exchange Commission. The SEC has certain standards that public corporations need to meet, and if and when you register then you’ve proven the trustworthiness of your corporation.
The good news is that this doesn’t have to be too complicated. You can do this online, by visiting the SEC website. You’ll need to fill out a form, and provide information regarding your corporation’s business activities and company management.
You will have to describe the stock you’re offering. Other required info includes a copy of your financial records, which need to be CPA-certified.
Each share must also come with official certificates, which can be in traditional paper form but can now be in an electronic version as well. The certificate will be proof of your shareholders’ stock ownership.
You will have to pay registration fees, but they’re fairly minimal. As of October 2020, the fee rate is $109.10 for every $1 million in shares.
Unlike LLCs, corporations can issue stock to potential investors. That gives you an additional way of raising capital for new business ventures. You’re not limited to just applying to banks for a loan. By issuing shares of stock, you can even obtain new capital fairly quickly.
It’s true that the entire process isn’t entirely simple. But now, you should have a clearer idea of what you have to do to avoid the pitfalls that may come up with issuing shares to raise money for your corporation.