Stock Issuance: Procedures and Requirements

Once a corporation has been formed, one of the initial formal corporate actions is the issuance of stock to the founders. This stock issuance typically occurs as part of the corporate formation process; however, a corporation may issue stock and other securities throughout its existence. Companies are encouraged to ensure that all securities (including stock, options, and warrants) are properly authorized, issued, and documented. Proper documentation and compliance facilitate due diligence by prospective investors or acquirers and support effective corporate governance. This article outlines the fundamental requirements to consider when a corporation issues any securities.

When is board approval required?

Board approval, either by written consent or at a board meeting, is required for every issuance of a security, whether that security is common stock, preferred stock, a warrant, an option or a note that is convertible into some type of stock. Securities are not validly issued without the approval of the company's board of directors. Ratifying and cleaning up the company's capitalization records can be a long and costly process, so ensuring the securities are validly approved by the board of directors at the time of issuance is a simple step that can help avoid headaches and unnecessary costs down the line.

Does the company get paid?

The security must always be "duly paid" for, meaning the company must receive something of value in exchange for the security. Payment may be monetary (such as cash, check, or agreeing to forego repayment of a debt owed by the company), property (such as equipment, technology, or intellectual property rights), or services (but only if those services have already been provided – promises to provide services in the future are not considered acceptable payment). Additionally, there are often tax issues to be considered when looking at different ways to pay for stock, which can vary based on the security holder's individual tax situation; companies are encouraged to consult with a tax attorney or accountant to avoid unintended tax consequences. For example, issuing stock to an individual as payment for past services typically results in the individual having to recognize and be taxed on the value of that stock as ordinary income.

What documents are needed?

The documentation required for the issuance of securities differs depending on the type of security. If the security is stock, the documentation would include board approval and a fully executed stock purchase agreement. If the security issued is a stock option, the documentation would include board approval, an independent third-party valuation (highly recommended), a copy of the stock plan, an option grant, and a fully executed option grant notice. If the security is preferred stock as part of a venture capital financing, the documentation will include board approval and a stock purchase agreement, as well as a suite of ancillary agreements (including a stockholder consent) that together are probably more paperwork than any first-time entrepreneur would ever expect.

The key here is to ensure that you have all the typical and required documentation signed, maintained securely and accessible – in turn forming the basis for a smooth due diligence process in a financing or sale of the company.

What is a securities filing?

The issuance of any security, no matter how large or small in quantity or value, must comply with state and federal securities laws. Those laws require that the company take certain steps to provide prospective investors with full disclosure about the company and the risks of the investment. Where a company is offering only a small amount of securities to a discrete number of prospective investors, or where the prospective investors are already aware of the risks of the investment (because they are already involved with the company as officers, or directors, for example), or the law has determined that they are able to bear the risk of the investment (because they have experience with similar types of investments or have a high net worth or high income level), a company may be able to rely on "exemptions" and not make the otherwise required, and sometimes extensive and time-consuming, disclosures. Whether an exemption may be available to a company or not, a document may need to be filed in order for the company to comply with the applicable state or federal securities laws. This is another matter that is routinely diligenced by prospective investors and acquirers of a company. An attorney can help your company ensure it remains compliant with these requirements.

Certificates: paper or electronic?

While public companies haven't issued actual certificates for stock for years, private companies have only recently started using "electronic" certificates. It is generally not difficult for a company to use electronic certificates, but there are certain steps a company must take in order for that use to comport with legal requirements.