Depending on which state you form your corporation in, you may need to issue stock. Some states require corporations to issue stock, while others make it optional. Before filing Articles of Incorporation, you should spend time researching whether the board of directors will need to issue stock. If given the option, you should weigh whether the new corporation should issue stock. Below, we’ve provided a breakdown of the pros and cons of issuing stock.
Stock Can Help Raise Money But At A Cost
If your new company is in need of capital, stock can provide you with the opportunity to raise money. Owners can then use this money to fuel business growth, allowing them to do things such as:
- Rent an office
- Purchase equipment
- Pay employees
- Pay debts
The downside, of course, is that incorporators are giving up a portion of the company when they issue stock. Each stock is worth a percentage of the company, as pre-defined by the board. However, the stock is also representative of the value of the company. Say, for instance, a new corporation issued stock at $1 per share. They decide to release one million shares. This means that they value the company at $1 million.
As a new company, this is likely not the case. Investors will request to see the company’s financials and realize that incorporators have overvalued the company. So, when a new corporation issues stock, it should be sure that the price per share and total shares are proportionate to the value of the company. Also, owners should remember that the more shares they issue, the more they will dilute their own holdings.
Common Stock V. Preferred Stock
If your new corporation is interested in issuing stock, you’ll also want to consider which type of stock to grant. Owners have the choice of issuing either common stock or preferred stock. Common stocks pay shareholders in both valuation and dividends. Rising share prices will create value for investors. Additionally, common stockholders receive proportionate votes on corporate issues, such as electing directors to the board.
Owners will want to keep this in mind when issuing stock because it can determine the future of the company. For instance, if one individual holds more than 50 percent of the shares that have been released, he or she can single-handedly control the company. So, for instance, if owners wanted to issue stock to raise capital, they should be careful not to provide investors with more than 50 percent of the shares. Otherwise, they’ll give up control of their new corporation.
On the other hand, there could be significant concerns about transparency were owners to hoard more than 50 percent of the shares. This could give the perception that each person’s vote is not equal and that those buying into the company will have no say in its direction because the owners are still in charge. This is a delicate balance that owners should be mindful of when issuing common stock.
The other option owners have is to issue preferred stock. When an individual owns preferred stock, they too own a share of the company. However, preferred stock pays a dividend that’s already been predetermined. The profits that a preferred stock pays are typically rather exorbitant and more substantial than the dividends that common stock pays. The other significant difference is that preferred stockholders do not vote on corporate matters.
The other significant difference between common stock and preferred stock should hopefully never have to come into play but is worth noting nonetheless. If the corporation were to go under and assets are liquidated, preferred stockholders would be able to redeem their shares before common stockholders. This means that preferred stockholders have a better chance of mitigating potential losses than common shareholders.
New corporations also do not have to issue one class of stock exclusively. Many new businesses choose to issue both common stock and preferred stock. The board of directors is in charge of issuing stock, although incorporators may need to provide a breakdown on the shares they wish to release on the Articles of Incorporation.
Is There An Alternative To Issuing Stock?
Some owners may not want to give away ownership of the company but would still like to raise capital. In this case, owners may want to consider selling long-term debt in the form of bonds. When a company does so, it agrees to pay investors their money back, plus interest. For instance, a corporation could raise cash by issuing $1,000 bonds with a five percent rate. This means that the corporation will need to pay the investor $1,050 when the bond expires.
Issuing debt could be beneficial because the government considers the interest that the corporation returns as a tax-deductible expense. Some investors may find bonds attractive because there is less uncertainty than with shares.
Bond-holders know precisely how much money they’ll give, how much they’ll receive in return, and when they can expect payment. However, bond-holders do not vote on corporate matters, so they do not play an integral role in defining the company’s direction. Another critical thing to consider is that the corporation can issue bonds at any time.
Technically, it can issue stock at any time it wants as well. But most corporations elect to only issue stock once, as doing so multiple times dilutes the value of shares that investors have already purchased. If the sole purpose is to raise capital for the company, new business owners could look into issuing long-term debt initially and then issuing stock at a later point when they are financially stable.
Key Reminders When Issuing Stock
If your company decides to issue shares, one of the other critical things to remember is the stock ledger. The stock ledger keeps track of every transaction of shares. It helps promote transparency and could prove beneficial for future investors. A new corporation will want to keep a detailed stock ledger that shows every purchase, sale, and distribution of shares the board has made throughout the company’s history.