Issuing shares of stock in a business creates enormous opportunities for growth. These issuances allow your business to raise capital for new projects with the added benefits of avoiding additional debt and spending cash already on hand. Share issuance also can be used as part of your business succession planning or to bring other qualified partners into your business.
While there are many benefits of issuing stock, the process can be tricky. In this article, we’ll give a high-level overview of the process.
1. Decide How Much Capital You Need
Like anything you do with your business, you’ll need to have clear goals for your stock issuance. Start by determining how much capital you want to raise and what you’ll do with it.
If you’re going to convince investors to buy your stock, you’ll need to make them feel confident that they will get a good return on their investment. As you create your growth plan, be able to present it in a clear and compelling way to potential investors.
It may be useful to have a target return-on-equity in mind. Return-on-equity is simply your business’s net income (your business’s total income minus expenses) divided by its shareholder’s equity (the amount shareholders have invested in the business).
To give a simple example, a business with an annual net income of $200,000 dollars and $150,000 in shareholder’s equity has a return-on-equity of 1.33, meaning an investor sees a 33% return on her investment annually.
Being able to offer a concrete number, such as 33%, to an investor has the dual advantage of increasing investor interest and holding you accountable to a target. Check out GrowGrade’s financial insight tool to get an idea of your companies current financial ratios.
2. Determine How Many Shares You’ll Issue
The number of shares your company can issue is listed on your articles of incorporation. However, if you want to issue more, it’s just a matter of amending the document. Most states charge a fee for processing updates, but the fee is usually small.
When deciding how many shares to issue, you’ll want to consider how many potential shareholders you’ll have. It’s also important to think about how the shares impact voting rights. Issuing fewer shares creates a smaller group of voters, which will increase the value of each share. Issuing shares without determining who you’re issuing them to, especially when share issuance are small, can allow the wrong people to obtain a majority stake in your business.
3. Get a Small Business Valuation
While you could randomly choose a share value based on how much money you need and how many shares you want to issue, it’s also important to make sure the value you choose is reasonable. Remember that you are essentially selling part of your business to shareholders. Before they commit, they’ll want to know they’re paying a fair price.
When completing this step, it’s best to work with a professional who knows how to determine the valuation of a business. After your valuation is complete, make sure you get documentation so you can provide it to your potential investors if necessary.
For a quick and free start, check out GrowGrade’s online valuation tool.
4. Set the Stock Price
Once you’re clear on how much you need to raise and what your business is worth, you can set your asking price. In some cases, you may find that you need to negotiate with investors to reach a price that they’re willing to pay.
5. Determine Whether to Issue Public or Private Stock
There are a few important decisions you’ll need to make before you can issue stock. The first is whether you’ll issue private or public stock. Public corporations can issue a virtually unlimited number of shares. However, they must register with the Securities and Exchange Commission (SEC), which is a rigorous, complex, and expensive process.
The majority of small business owners will issue private stock. This limits the number of shares you can issue and only allows you to sell them to the corporation’s founders, owners, and private investors. However, it’s far easier than dealing with all the hoops you would need to jump through for a public offering.
Again, this process is extremely complicated, and you’ll often want to consult with your lawyer, accountant, and banker during the process.
6. Decide What Type of Stock to Issue
After you’ve decided whether you’ll go public or private, you’ll also need to decide what type of stock you’ll issue. If your company is structured as an S Corporation then you’re only allowed to issue one class of stock – common stock. However, C Corporations can issue multiple types of stock. While there are several options, common and preferred are the two most popular types.
Common stock gives shareholders voting rights and are popular due to their potential for long-term growth. Preferred stocks usually do not grant voting rights but give the shareholders more security. If you’re late paying dividends or owe any type of debt to your shareholders, owners of preferred stock are paid first.
7. File Your Legal Documents
While a private placement doesn’t require you to register with the SEC, you must still comply with state and federal laws and submit all the required filings. In addition, you’ll need to draft a shareholder agreement.
This document outlines the rights and privileges you’re granting your shareholders in exchange for their monetary investment. It’s a contract between your corporation and your shareholders and it protects both the shareholders and your company.
The agreement should include important details like the shareholder’s voting rights, control over the company’s board of directors, their rights to dividends, and more. It will also explain how and when new shareholders can buy into the corporation.
When completing the required filings and drafting your shareholder agreement, it’s best to work with a skilled attorney who has experience in issuing shares. This will help ensure you stay in compliance and allow you to avoid any unexpected problems.