The ability of a company to issue stock is a crucial element of modern capitalism. Selling stock, which represents an ownership share in a company, allows companies to raise money for growth and expansion. Stock options are also used as an employee incentive, especially in the startup phase.
C corporations are the only entities that issue stock. Other types of business entities such as limited liability companies (LLCs) and partnerships do not issue stock. While stock is often associated with exchanges like the New York Stock Exchange (NYSE), most companies that issue stock are not publicly traded. Privately held companies may issue stock, but their stock can be more difficult to value and less liquid. Corporations must address stock issuance in their governing documents, which should clearly address related legal issues.
Joint-Stock Companies and the Modern Corporation
When people discuss stocks, they are typically referring to the stock of companies listed on major stock exchanges such as the NYSE or the Nasdaq Composite. About half of Americans have invested in the stock market.[1] There are hundreds of stock markets worldwide where shares of public companies are bought and sold.
The modern stock exchange traces its origins back to fourteenth century Venetian moneylenders who acted in a similar capacity to today’s brokers. Antwerp, Belgium had a stock exchange in the 1500s that dealt in promissory notes and bonds, because there were no stocks as we now think of them.[2]
Actual stocks, or shares in companies that are sold to investors and entitle them to a percentage of a company’s profits, were first issued in the 1600s by European ship owners. The joint-stock company,[3] the forerunner of the corporation, was a vehicle for funding overseas imperial ventures. It allowed companies to raise money for voyages, and investors to pool resources and spread risk with the hope of large profits.
Individual shareholders in a joint-stock company were not responsible for a company’s actions. In addition, they only risked losing an amount of money equal to their original investment.
Private versus Public Company Stock
Corporations in the twenty-first century retain the primary feature of joint-stock companies, which enabled these early companies to become so successful.
Namely, they can sell shares to investors that become partial owners of the company. This allows corporations to raise money for undertakings that require significant capital. Shareholders are generally not personally liable for a corporation’s debts or obligations. But when the value of its stock increases, which can result from strong earnings or the perception that the company will earn and grow, shareholders are enriched.
Public Company Stock
The companies traded on US stock exchanges begin as privately held corporations. At some point, a corporation may decide to go public and make its shares available to the public through an initial public offering (IPO). Companies that issue an IPO usually do so to raise capital for paying off debts, funding growth, raising their public profile, attracting and compensating employees, or permitting company insiders to diversify their holdings or create liquidity by selling their private shares in the IPO.[4]
Companies that conduct a public offering, however, must comply with Securities and Exchange Commission (SEC) registration requirements. After the IPO, public companies must also comply with SEC reporting and recordkeeping requirements for transparency purposes.[5] Company insiders (i.e., officers, directors, and shareholders of 10 percent or more of publicly traded companies) may have additional reporting requirements.
Private Company Stock
Not all privately held corporations go public. Many, including big names like Deloitte, Ernst & Young, and Koch Industries, remain private. That is, they never make an IPO or issue publicly traded stock. Private corporations may still issue stock—they just cannot sell it to the public via stock exchanges.
Private companies can raise capital by making stock offerings to a limited investor pool. So-called private placements are an alternative to the IPO that do not require SEC registration, although certain SEC regulations still apply.[6]
The value of the stock of a private company that later goes public can increase substantially. But unlike public stocks that shareholders can readily buy and sell on exchanges, private companies often limit the sale and purchase of their stocks. A company might require permission to sell private stock and have the right of first refusal, which provides it the option to buy back the stock before other investors can buy it.
It may be more difficult to find a buyer for private stock because prospective buyers cannot access nonpublic research documents about private companies the way they can with public companies. Valuation may also be difficult for private stock, which is not subject to free market exchange pricing. For these reasons, private stock is illiquid compared to public stock.
Private companies may also issue stock as employee compensation in lieu of cash. This type of equity is popular during the startup phase when cash flow is limited. Employee stock options can incentivize workers because the value of their stock is tied to the company’s success. Like private investors, though, employees may require company permission before selling their private stock and they may be required to sell it when they leave the company.
How to Issue Stock
Before a company can issue a single stock, it must first authorize shares. Authorized shares are the maximum number of shares a company may issue as set forth in its governing documents. They are contrasted with outstanding shares or the actual number of shares that have been issued to investors and/or employees.
The number of authorized shares is stated in the articles of incorporation. Company rules for authorizing shares are stated separately in the corporate bylaws. For example, the bylaws may require a special vote of the shareholders to authorize shares, or to change the number of authorized shares. Every issuance of a corporate security, including stock, requires approval from the board of directors.
Corporate bylaws should also describe the form the stock certificate takes. These days, both public and private companies mostly issue digital stock certificates instead of paper certificates. Since some shareholders might still want a physical share certificate, the bylaws can stipulate the process for issuing them.
The following other documentation are needed for issuing stock:
- Written board approval
- Independent third-party valuation of the stock
- A stock plan and option grant (for a stock option issued as employee compensation)
- Stock purchase agreement and ancillary agreements, such as a stockholder consent form (for stock issued as venture capital financing)
Note that the specific documentation requirements can vary based on the type of stock issued (e.g., common stock, preferred stock, custom stock, voting versus nonvoting stock, management shares, preference shares) and the type of stock plan granted to employees.
Once internal preparations have been made for issuing stock, corporations need to make sure they are complying with applicable federal and state security laws. This is necessary regardless of whether the offering is public or private. Companies must carefully record and track stock transactions to avoid issuing more stock than authorized. Stock certificates, which are subject to issuance timelines, show who owns company shares and how many shares they own. When stock changes hands, records should be updated accordingly.
If your corporation has questions about issuing, buying, and selling stock—whether it is founder stock, investor stock, employee stock options, or an IPO, our business attorneys are here to help. Call or contact us to schedule an appointment.
[1] Lyle Daly, How Many Americans Own Stock? About 150 Million — But the Wealthiest 1% Own More Than Half, The Motley Fool (Jan. 19, 2023), https://www.fool.com/research/how-many-americans-own-stock/.
[2] Andrew Beattie, The Birth of Stock Exchanges, Investopedia (Mar. 14, 2022), https://www.investopedia.com/articles/07/stock-exchange-history.asp.
[3] Joint-Stock Companies, U.S. History, https://www.ushistory.org/us/2b.asp# (last visited Apr. 10, 2023).
[4] Should my company “go public”? U.S. Sec. and Exch. Comm’n (Apr. 6, 2023), https://www.sec.gov/education/smallbusiness/goingpublic/companygoingpublic.
[5] Exchange Act Reporting and Registration, U.S. Sec. and Exch. Comm’n (Apr. 6, 2023), https://www.sec.gov/education/smallbusiness/goingpublic/exchangeactreporting.
[6] Private Placements, Explained, FINRA (Dec. 7, 2020), https://www.finra.org/investors/insights/private-placements-explained.
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