Do I need to issue a stock certificate for my company?
In this article, we will discuss various ways of documenting this relationship.
Companies sell their shares in the market to raise capital for expanding the business. People who buy these shares are the shareholders and they share a special relationship with the company that tends to last for years. In a way, they share the responsibility of the company’s success, gain from their profits, and equally share the liabilities of loss. In this article, we will discuss various ways of documenting this relationship. Let us begin by understanding stock certificates.
Why stock certificates?
When a company is incorporated, it is natural for the founders to envision a legacy. This is a long-term goal and will take several years of committed planning, hard work, and intelligent operations to achieve it. All through this journey, record-keeping is crucial and ensures that all the important activities of a company are documented for proof and reference. Stock certificates held by company shareholders are one such record. But why issue stock certificates?
Why does a company need to issue a stock certificate?
Companies issue stock certificates to their shareholders as proof of stock ownership. It is a legal document certifying the rights of a shareholder over company stocks. Many companies are gradually moving away from the practice of issuing share certificates and issuing a holding statement instead. However, it has been a practice of companies to issue stock certificates in the following situations:
- Share transfer – When an existing shareholder transfers rights to another shareholder, be it an individual or a company. The original owner can choose to sell partial holdings or all of it, and depending on the decision, the original certificate will be canceled and two new ones will be issued.
- Share allotment – When a company issues new shares to new shareholders. In this case, the company will issue new stock certificates to all shareholders. They could be in the form of paper certificates or electronic ones. We will discuss these in detail in the later sections.
- Loss or damage – When a shareholder notifies the issuer about a loss or damage of an existing certificate, the company will issue a new one as a replacement. But the damaged stock certificate has to be submitted to the company before collecting a new one.
Irrespective of paper or electronic stock certificates, the basic format is more or less the same. A typical stock certificate carries details of the company and the shareholders. Accuracy of these details is paramount. Following are the basic information included in a stock certificate:
- The serial number of a stock certificate
- Date of issue
- Full name and registered address of the company
- Registration number of the company
- Number of shares, asset class, and buying price of shares
- Stock restrictions
- Full name and contact details of the shareholder
- Signatures of company’s authorized signatories
- Company seal
The company secretary is responsible for issuing stock certificates, but the certificate has to be signed by two directors. In some cases, one director signs along with the company secretary. Companies having only one director will have to invite a witness to attest the signature. Physical signatures are used in paper certificates through electronic signatures and electronic stock certificates are equally valid now. Then why continue with paper stock certificates? Before addressing this question, we must know two important aspects of share trading:
- Certificated and uncertificated shares – Not all shares are certificated. A company can choose to issue stock certificates or not based on the company size, asset class, and quantity of shares purchased. When a company provides a certificate (paper or electronic) as a receipt of share purchase, those are known as certificated shares. Meanwhile, uncertificated shares are tracked by the book-entry method and no certificate is provided. Transfer of share ownership is tracked by simply updating details of the stock owner in the company ledger.
- Mode of holding stocks – a shareholder can hold stocks in three ways – physical certificates, where stocks are registered in the name of the investor, hard copy of the stock certificate is issued, and all paperwork and dividends are sent directly to the investor; street name registration, where stocks are registered under the name of the brokerage firm and all documents and dividends are sent to this firm to be further distributed to investors; and direct registration system, where no brokerage firm is involved and the investor deals with the company’s transfer agent directly. The investor’s name is mentioned in the company ledgers.
Should companies still issue paper stock certificates to shareholders?
Traditionally paper stock certificates have been the norm. But public companies with thousands of shareholders have long abandoned them and moved to the DRS system. However some private companies still have not made the shift. Some investors still demand paper certificates owing to their credibility as compared to company ledgers. Electronic stock certificates are a long shot too. Some glaring limitations with paper stock certificates are:
- Owing to multiple share transfers over time they are hard to track and manage
- They can be transferred to new owners without the company’s knowledge
- Difficult to track all certificates making audits cumbersome
- Complicates the process of selling the company
- Compliance becomes harder
- They do not accurately reflect the shareholder’s current holdings
Is issuing an electronic share certificate a better option?
Electronic stock certificates, though a step forward towards digital equity management, is still a certificated share. The only difference is that instead of a physical paper, it is issued as a digital PDF. Once opted into this mode, companies can issue new stock certificates attested with electronic signatures and store them on a cloud server. In addition to this, they can request all shareholders to hand over their paper stock certificates and reissue them in the PDF format.
However, electronic stock certificates have some drawbacks too. The legal classification of these types of shares is not well established yet. Neither does any law prohibit them. It is in a way a grey area that some traditional investors and companies may want to avoid. Additionally, it might be a cumbersome process to track all physical certificates and re-issue them in the digital format. The cost incurred in this process may not be justified.
Making the shift to uncertificated shares
Equity management is increasingly shifting to a digital format and processes have gone beyond electronic stock certificates. Today’s markets offer efficient equity management software which has moved the book-entry method a step forward by allowing personalization in the user interface. Hence shifting to uncertificated shares is the need of the hour. This switch can be easily made by following these steps:
- Step 1: Get the board of directors to authorize issuing uncertificated shares
- Step 2: Create a board resolution stating the same
- Step 3: Amend the company by-laws and the article of incorporation to the same effect
- Step 4: Issue uncertificated shares and track everything electronically on a company ledger
Example: Brokerage Firms use Direct Registration System (DRS)
Public companies have long abandoned certificated shares and shifted to DRS. DRS enables the investor to be registered directly in the company books without the need of a physical stock certificate. All share sales are recorded simply by updating the details of the stock owner instead of issuing stock certificates. The mechanics of the sale is however complicated involving brokers, custodians, clearinghouses, regulators, etc.
New investors may not directly interact with company transfer agents. They will mostly invest in stocks through brokerage firms. For example, if you own 1,000 shares of ABC Inc. through the services of a brokerage firm X & Company, your stock will be collated with all other brokerage clients holding stocks of ABC Inc. and reported in the books of ABC Inc transfer agent under X & Company.
But the problem with this arrangement is that the investor will land in trouble if the brokerage firm goes bankrupt. Hence as an investor, one has to evaluate the pros and cons of using the DRS and figure out if it suits their abilities and needs. Investors have the option of either dealing directly with company transfer agents, or working with a brokerage firm to arrange trades registered through DRS, or simply trust the brokerage firm to work out the best investment options. The issue of stock certificates will depend on the mode of trading.
Who is an ideal DRS investor?
Since all businesses have not yet made the shift to uncertificated shares, as a company how will you identify DRS investors? Who do you think fits your profile to pitch DRS investments? Here are some pointers:
- One who plans to buy a large number of stocks in a particular company
- One who plans to hold those shares for the next couple of years without quickly transferring them to another investor for a quick buck
- One who finds holding paper stock certificates cumbersome and risky
- One who trusts uncertificated shares and is not particular about electronic stock certificates as well
- One who prefers to receive annual reports and other investment-related documents promptly
- One who is willing to trust the financial institution they are dealing with
How to sell DRS held securities?
Investors accustomed to using physical stock certificates or electronic stock certificates are used to physical proof of share transfer ie. owning freshly issued stock certificates with all updated details of the share transfer. Convincing them about the simplicity of the DRS system can be a challenge in the initial phases. But selling DRS securities can be very simple. The investor can simply instruct the share issuer to do so.
Many issuers have special programs in place to accommodate sale requests. Otherwise the investor can instruct the broker-dealer to electronically move their securities. As a backup, they can request a physical certificate and present it to any financial institution asking for physical proof.
As covered in this article, equity management has moved on from electronic stock certificates, and uncertificated shares are the future now. Many states are adapting their business laws to encourage this shift. In addition to this, specialized equity management software is available that makes stock issuance and tracking simple, accurate, and efficient.
Eqvista is one such state-of-the-art software. It is a one-stop destination for entrepreneurs to record and manage their company stock. One can incorporate their company and manage equity all in one place. It has never been easier to issue shares as well as electronic share certificates. To discuss your options, reach out to us today!