How Corporate Stock Works: Types of Stock and How to Issue It
Corporate stock refers to a type of ownership in a legal business entity, such as an C-corporation. Corporations typically issue stock to raise money from investors to fund capital expenditures or future growth. Typically corporate stock is broken up into common or preferred stock. Both can be beneficial depending on what the situation is for your business.
If you’re interested in issuing stock to raise money then you should make sure your business is setup as either an S-corporation or a C-corporation. MyCompanyWorks can help you whether you’re a brand new business or you currently have another entity type, like an LLC, that needs to transfer over. You can quickly fill out the online form to get the process rolling today.
What is Corporate Stock & How it Works
Corporate stock is broken up into shares that constitute an ownership interest or equity in a business. Each share represents a proportionate ownership interest in the corporation. Shares of corporate stock can be purchased and sold in two different ways: either via a single private transaction, typically to a single private purchaser, or to many purchasers through a regulated stock exchange.
Just because someone owns corporate stock doesn’t mean they have any legal obligations to the business itself. However, all financial benefits of stock ownership must be reported to the IRS as income to the individual. If there is a financial event, such as a dividend paid by the company or a sale of the stock of the company, then the shareholders could benefit depending on the legal rights of any debtor’s of the business.
There is no set number of shares that a business must issue when deciding to sell or give corporate stock. Many businesses will start out with between 1,000 – 100,000 shares of stock that is typically broken up between common stock and preferred stock. Those owning common stock are shareholders that have voting rights based on the number of shares they own. The number of total shares can increase as the business grows.
Why Companies Issue Stock
Generally a business issues stock in order to prepare for a financial event, such as raising money to grow the business or in preparation of taking the company public. Instead of taking on debt financing, like issuing bonds or taking out a loan, a company will issue stock to raise money through what is called equity financing.
You may want to issue stock for a number of reasons, including:
- If you can’t, or don’t want to, take on debt due to cash flow or credit issues.
- If you need more cash available than debt financing would allow.
- If you lack sufficient assets to take on debt financing.
- If you’re planning to grow quickly and can’t afford to be viewed as a risk due to debt.
However, you may want to consider not issuing stock and selling shares of the business if you’re worried about giving up ownership of your business. In order to get the shares back you’ll need to buy them back in the future, if the shareholder agrees to sell. If you sell too many shares of your business then you could end up struggling to have the power to make big decisions for the business.
Types of Stock
Typically, all corporate stock is broken up into either common stock or preferred stock. Common stock can provide a larger increase in value if the business grows but preferred stock typically allows for a more consistent dividend.
Common Stock
Common stock is the most popular and widely used type of stock. This is the type of stock that has all of the traditional power of being a business owner. These shares are allowed voting rights and whomever owns the majority of the common stock controls the decisions that are made within the business. Common stock is often believed to be the type of stock ownership with the best return on investment. Shareholders may earn dividends but they vary and are never guaranteed.
The two types of common stock are:
- Common Growth Stock: This is typically the type of stock referred to when someone wants to issue “common stock”. Shareholders owning this type of stock have voting rights and can receive dividends but the most common benefit is the increase in value per share that shareholders can earn from a fast growing company.
- Common Income Stock: This is similar to common growth stock but is considered to be a more secure investment. This type of stock is typically issued by well established businesses. Instead of profiting off of the quick growth of the business, shareholders benefit from high dividends.
Preferred Stock
Preferred stock also represents ownership of the business but typically does not come with any voting rights. Instead, shareholders are just looking to profit off of the growth of the business without having anything to do with the operations. When dividends are paid out on preferred stock then the business typically guarantees a set amount per dividend in perpetuity. For example, as long as the company hits certain financial parameters, each share pays out a dividend of 5% per quarter.
Convertible Preferred Stock
Convertible preferred stock operates as normal preferred stock with dividends and no voting rights with one big exception. The owner of this type of stock has the right to trade their shares for common stock by a pre-specified date. This is typically a nice balance for someone that needs income in the present day but who still values the long-term investment of a growth stock.
Corporate Stock Classes
While common and preferred stock are the two main types that are issued, your business can classify stock any way you would like to. Most of the time this means issuing different classes of stock for the sole purpose of breaking up the voting rights. The most common classes are classified as class A and class B stock.
For example, you could issue class A common stock and class B common stock. Class A could have 100 votes per share and Class B could have 25 votes per share. This enables you to better control who has the decision-making power with the business as you continue to raise equity financing.
Which Type of Corporate Stock to Issue
The type of stock your business decides to issue is dependent on what your goals are. If you’re looking to raise money and are willing to pay out a consistent dividend then you’ll likely want to issue preferred stock. However, if you don’t want to pay a dividend or want it to be dependant upon company performance then you may want to consider common stock instead.
The key thing to keep in mind is that regardless of your strategy or the types of stock you issue there are ways to make sure you keep the controlling interest in the business. You just need to make sure you break up the stock into different classes or only issue the controlling number of common stock shares to yourself.
How to Issue Stock
If you’re looking to issue stock then you should follow a number of steps to make sure you do it correctly. The key here is that you don’t want to do this on your own. You should consult the proper attorneys that will enable you to legally issue the type of stock that will benefit your needs.
Here’s six steps you can follow as you look to issue corporate stock:
- Form a Corporation: In order to issue stock you’ll want to be either an S-corporation or a C-corporation. You can get started here.
- Determine Your Funding Needs: Before issuing stock you should know how much capital you’re looking to raise so that you and your advisors can properly strategize what you need to do. This amount will guide the entire process.
- Determine How Many Shares You Can Issue: Before you can issue any corporate stock you need to know how many shares to start with. The articles of incorporation within your corporation’s registration will provide a maximum number of shares but you do not have to issue all of those shares at one time.
- Get Your Business Valued: Getting a business valuation will help you determine the value of each share of stock so you can properly sell the shares.
- Determine the Type and Class of All Shares: This is where you work with your advisors to make sure you’re issuing the right types of corporate stock that will help you achieve your business goals.
- Check All Securities Laws: Work with an attorney to make sure you’re in compliance with all securities laws.
Each of these steps requires careful consideration of both the laws and your business’s goals. While issuing corporate stock can be very beneficial to the short-term gains of your business, you may regret issuing stock down the road if you don’t do it correctly. You should also consider alternatives to issuing stock before jumping in and doing it, such as taking out a loan.
Getting Started
Issuing corporate stock can be a complicated process, but it can help you raise the capital you need to achieve your lofty growth goals. The first step is to make sure your business’s legal entity is a corporation. You can get the process started by filling out a simple online form.