By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C.
One of the first formal corporate actions to be taken following the formation of a corporation is issuing stock to the founders. Stock issuance to founders typically occurs during the formation process, though a company will continue to issue various securities through its growth and development. This article will outline five considerations to keep in mind as your company issues securities.
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1. Board Approval
Any security to be issued requires approval from the board of directors. Regardless of the type of security, whether common stock, preferred stock, stock options, warrants, or convertibles notes, it is necessary for the board of directors to provide either written consent or approval at a board meeting. Ensuring securities have board approval validates the issuance of the security and is a simple administrative task that prevents complications in the future.
2. Payment for the Security
In return for the security, the company must receive payment. This payment can be monetary, property, or a service. Monetary payment can be made by cash or check, or an agreement to forgo a debt payment owed by the company issuing the security. Property of value that can be used as payment includes equipment, technology, or intellectual property rights. If a service is being used as payment, it must have already been provided and not be a promise to provide a service in the future.
When deciding on a payment option for a security, it is important to consider any tax issues that may arise. It is best to consult with a tax attorney or accountant as they will be able to advise the best payment option for each security holder.
3. Required Documents
The documents required when issuing securities will be dependent on the type of security that’s being issued. Below are the documents required for commonly issued securities.
Common stock
- Board approval
- Complete stock purchase agreement
- If insufficient number of shares authorized, charter amendment, stockholder approval and other approvals
Stock options
- Board approval
- Independent third-party valuation
- Stock plan
- Option grant and complete option grant notice
Preferred stock
- Board approval
- Complete stock purchase agreement
- Stockholder consent (watch for any class votes required)
- Ancillary agreements
Ensure that all required documents are prepared, signed, secured, and easily accessible. This will allow diligence by future investors to proceed without issue during financing or sale of the company.
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4. Securities Filings
When issuing securities, a securities filing is often required to comply with state and federal securities laws. These laws require companies to fully disclose information regarding the company and associated investment risks. It is typical for companies to seek exemptions to these securities laws so that they do not have to provide full disclosure. Exemptions can be applied to the following situations:
- The number of securities being issued is small, and they are offered to a discrete number of potential investors
- Potential investors are already involved with the company to some degree so they are aware of the risks that may be associated with the investment
- Potential investors that have previous experience with similar investments, a high net worth, or a high income will be seen as able to bear the risk of the investment
Even if an exemption is employed, a securities filing may still be required to comply with the law. It is important to consult with your legal team when submitting any securities filings to ensure that all necessary laws are being complied with. Maintaining accurate records of all filings will also permit diligence by investors during any future transactions.
5. Stock Certificates
The final thing to consider when issuing stock is whether to issue a paper or electronic stock certificate. Public companies only issue electronic certificates, however private companies may choose whether a paper or electronic certificate would be more suitable. Increasingly, private companies are working with cloud-enabled vendors to issue electronic certificates.
