As the owner of a private corporation, it’s important to understand your options when issuing stock. After all, not all stock is the same; the type you issue depends on your business structure and equity goals.
Classes of stock: Common stock versus preferred stock
There are two main classes of stock: common stock and preferred stock. Common stock generally goes to company founders and early employees, while preferred stock is usually reserved for investors. The two stocks differ in terms of their price, how they’re paid out, and what voting rights (if any) they come with.
Common stock gets sold at the fair market value, which is how much a share of your private company’s stock would be worth on the open market. Preferred stock often sells at a higher rate based on your company’s valuation.
Preferred stockholders are first in line for payouts. That means that if you liquidate your company or get acquired by another company, you’ll pay dividends to preferred stockholders before distributing any money to common stockholders.
Preferred stockholders also usually collect fixed dividends based on the price of the stock. Here’s how that works: instead of paying preferred shareholders only during transactions or liquidation events, you’ll also pay them at regular intervals—usually quarterly or monthly. However, if your company is struggling financially, you can usually opt to skip a dividend payment.
Common stockholders, on the other hand, don’t have fixed dividends. The dividends can change depending on your company’s profitability, and you may not even want to offer them at all.
Common stockholders have the right to vote on major company decisions, like new executive hires and corporate policy changes. Preferred stockholders generally don’t have the same voting rights, but as the company founder you can decide whether or not you want to offer certain voting privileges.
A share class is a category of stock under the umbrellas of common stock or preferred stock. You don’t have to create multiple share classes in your corporation, but it’s a helpful way to either extend or restrict your shareholders’ voting privileges.
Among common stockholders, for example, you could create three different share classes and give each one different voting rights. You could give Class A shareholders 50 votes per share, Class B shareholders 25 votes per share, and Class C shareholders 10 votes a share. You could also create a share class of non-voting common stockholders. Dividing your common stock into different classes allows you to control who has more influence over the direction of your company.
You can also create unique share classes among your preferred stockholders. There are several options, depending on what types of benefits or rights you want to extend. You could:
- Create a share class that gives stockholders a higher fixed dividend if you generate significant profits
- Create a share class that lets stockholders take advantage of cumulative dividend payments in the event that you skip a regular dividend payment
- Create a share class that gives stockholders preferred stock that can convert to a set amount of common stock if a specific amount of time has passed
Issuing stock as a C corp versus an S corp
C corporations and S corporations have different rules for issuing stock. As a C corp, you can issue both common and preferred stock. From there, you can create different share classes with different voting rights. You can also offer dividend payments to shareholders.
S corps, however, can only issue one type of stock. They also pay distributions (not dividends) to shareholders. Dividends and distributions are both a share of company profits, but C corp dividends are subject to double taxation (corporate taxes and individual taxes), while S corp distributions are taxed once.
If you own an S corp you have to abide by the following IRS rules:
- You can only issue one class of stock.
- You can’t give stock to more than 100 shareholders, which prevents S corps from being publicly traded.
- Shareholders can be individuals (who are citizens or legal residents), estates, and certain trusts.
- Corporations, partnerships, and non-resident shareholders are not allowed.
As an S corp, you can still create different share classes within your one class of stock. Depending on your growth and financial goals, you may want to give certain shareholders no voting rights, some shareholders all voting rights, and some the right to vote only on certain issues.
How to issue stock as a corporation
If you’re ready to issue stock, take the following steps to prepare:
1. Revisit your company’s articles of incorporation
Your company’s articles of incorporation—the formal documents you filed when creating your organization—should stipulate the maximum number of shares your company can issue, as well as whether or not you’re allowed to have multiple classes of stock.
2. Determine your goals for issuing stock
Think about why you want to issue stock. Would you like to reward your early employees for their loyalty and hard work? Do you need to bring on investors to raise money? If so, how much money do you need to raise to reach your immediate growth goals? What voting privileges do you want to offer stockholders?
The answers to these questions will help guide your decisions.
Next, consult your lawyer to help you figure out how many shares to issue. The exact amount depends on a number of factors, including:
- Your articles of incorporation: There’s a maximum number of shares you can issue, but you may not want to hit the maximum right away. If you plan to fundraise in the future, it can be helpful to set aside a certain portion of shares for investors.
- Your voting preferences: Consider how much influence you’re willing to give your shareholders. Keep in mind that the more shareholders there are, the less voting power each individual shareholder has.
- Your company valuation: It’s important to get a company valuation to determine the price of your stock. Understanding the potential value of each share gives you a better idea of how many shares to issue and to whom.
Need a quick refresher on a few key terms? We’ve got you covered:
Equity: A type of ownership in a company. Business owners often give equity to investors in exchange for their money, or to employees as a company benefit.
Stock: A type of security employees and investors can receive as equity.
Share (of stock): A piece of ownership in a company. A shareholder (also called a stockholder) is an individual or entity that owns stock.
Dividend: A cash or stock payment that can be issued to shareholders of a profitable C corporation.
Fair market value: The price of a share of common stock (more on that below) as determined by a 409A valuation. Private companies typically undergo 409A valuations every year.