Does your company give stock certificates to its shareholders? If so, have you ever thought about why? If you don’t have a good answer, that’s ok – a lot of companies still issue them, and a lot of lawyers still recommend them. Our view is that stock certificates, either in paper or electronic form, don’t add a lot of value for a company. There are a multitude of really good options for electronically tracking share ownership. In an increasingly digital world, issuing stock certificates may not be worth the headaches they can cause.
What Are Stock Certificates For?
Stock certificates do two main things: they provide evidence that a person owns equity in a company, and they serve as a company’s record of share ownership. If a person buys a share of stock and is issued a stock certificate, the certificate will list the name of the company, the number of shares issued, and the date the shares were issued. The certificate itself will also be signed by one or more company officers. The company which issued the certificate will keep a copy for its own records, and this allows the shareholder and the company to know who its shareholders are. When someone wants to sell their shares, the stock certificate is cancelled, and a new one is created for the new shareholder. Typically, each share transfer will cause an additional certificate to be created. It’s common for shareholders to have two or more certificates, each listing the number of shares purchased.
Are Certificates Required?
No. All states allow share ownership to be tracked in ways other than issuing stock certificates. In Delaware, a company can avoid issuing certificates by having the board of directors authorize it before issuing any shares of stock. A lot of lawyers advising Delaware companies will default to the use of stock certificates without first asking the founders if they want to use them. Our view is that with some simple planning, companies can avoid their use altogether and save unnecessary legal costs connected with creating, tracking, and distributing the certificates.
What’s Wrong with Using Stock Certificates?
In our opinion, issuing stock certificates isn’t something which adds value to your company. If your company functions on a lean business model, you know that if something doesn’t create value, you don’t need it. In many instances, stock certificates become a hassle which can cost you time and money down the road. Here are just a few reasons to consider going stock certificate-free:
- Shareholders often lose their stock certificates, requiring the company to issue new ones or eventually get the shareholder to sign an affidavit stating that the certificate is lost (this is frequently an added step for a company which undergoes an exit).
- The law firm handling the stock certificates must coordinate and record the names of the company’s shareholders, the number of shares, the date issued, and any language on the back of the certificate itself which restricts transfer. The law firm must also choose the form of certificate used, and have a system of scanning and printing, or otherwise creating, each individual certificate. The certificate should look different for each class of stock issued, in order to avoid confusion about which class of stock is owned by which shareholder. All of that work requires a lot of coordination between the law firm and the company. At hourly billing rates, tracking this information can get very expensive. And, even at the most sophisticated law firms, mistakes can and do happen, requiring time-intensive corrections.
- If the company issues paper stock certificates – which requires only slightly more work than creating electronic certificates – then the company must factor in the cost of postage, along with the additional expense of creating cover letters and other correspondence to deliver the certificates to the shareholders.
- Shareholders often receive or transfer shares of stock in small groups over time. A common example is when a holder of stock options requests to purchase shares which have vested. It is therefore possible for one shareholder to have several stock certificates in his or her name, which increases the likelihood for error.
Is There a Better Alternative to Using Stock Certificates?
We certainly think so. Carta is a company which offers electronic equity management and is a popular alternative to using stock certificates. For companies looking to keep expenses as low as possible, a spreadsheet in Microsoft Excel works well. Keep in mind that for any recordkeeping of equity ownership, entering share transfers promptly is the key to having a complete and accurate capitalization table.
Summary
At Peak, we use technology to its fullest extent to provide individualized, efficient legal services to our clients. While much of the work we do cannot be automated, some of it can. We encourage our clients to ask us about technology which can help them avoid unnecessary expenses. Ditching the stock certificate might be something to consider.
Bob Baker is a founding partner of Peak Corporate Counsel. He has worked with numerous founders on a variety of issues specific to startups. When he’s not advising innovators, he can be found at networking events, playing rugby, or hiking with his kids.
This article is for informational purposes only, and may not be considered legal advice.