Should My Corporation Provide Stock Certificates to Shareholders?
Let’s assume that you are one of the founders of a new corporation. Should the corporation provide stock certificates to shareholders when their shares are issued?
For most startups formed in California, the answer is “yes” – and not merely because the founders will feel good having tangible evidence of their ownership interests.
Requirements for Shares without Certificates
California Corporations Code Section 416(b) allows the issuance of shares without certificates under certain circumstances. Please note, however, that a corporation may adopt an electronic share management and transfer system only if that system:
(1) has been approved by the United States Securities and Exchange Commission, (2) is authorized in any statute of the United States, or (3) is in accordance with Division 8 (commencing with Section 8101) of the Commercial Code.
There are, of course, electronic systems that satisfy these requirements. However, as a practical matter, most closely held corporations (those that are owned by a small number of shareholders) will need or choose to provide paper stock certificates, because they do not have experience with approved electronic systems.
Corporations Code Section 418 specifies a variety of circumstances under which share certificates must include written statements providing notice of the existence of those circumstances. These include, for example, restrictions on share transfers or voting rights – both of which are common in multi-founder corporations.
Furthermore, that section states that if a required statement is not included on the certificate, the corresponding restriction will not be enforceable against a transferee who is unaware of the restriction!
Considering Sections 416(b) and 418 together, we find that:
- The corporation must provide required statements to share transferees; thus
- If the corporation wants to use an electronic system, the system must be capable of providing the required statements.
Major Reason for Stock Certificates
This brings us to the major reason why most startups should provide paper stock certificates: So that, with the proper statements included, shareholder buy-sell, voting rights, and other agreements can be enforced as the parties intended.
Dana H. Shultz, Attorney at Law +1 510-547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.
Business Entities, Startup
11/25/2012 | 7:50 am Permalink
Wouldn’t it be better to provide no physical certificates and require the Company approval for any transfers? This way the transferee can be required to acknowledge transfer restrictions in writing and to be bound by them. Stamping a legend on a certificate seems a less desirable means of accomplishing this end.
11/25/2012 | 8:48 am Permalink
You obviously have not read the code sections referenced in this post. If you do read them, you will see that – absent electronic registration of shares, which is not feasible for a closely-held corporation – certificates and certain types of legends are required by applicable law.
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