Important Legal Considerations When Issuing and Transferring Shares
By Alex Tanglao, Last updated: 2022-06-06 (originally published on 2022-02-22)
As a business owner, managing your shareholding is a fundamental part of running your business. Unfortunately, that can also be one of the most challenging pieces of the puzzle to figure out. What are the legal considerations you should keep in mind? Consider these:
Can I have an arrangement where some shareholders have more powers than others?
Must I seek anyone’s approval if I want to transfer the shares from one of my existing shareholder to a new shareholder?
These are some of the questions business owners may have, and understandably so, since shares represent ownership and decision-making power in a business. Here, we list five considerations you should have when issuing and transferring shares.
1. Share issue and transfer terminology
If you are looking to get first-time shareholders-to-be on board, it is crucial to get on the same page about their stake in the company. There are several terms that people may use to refer to shares in a company:
- A stock is a portion in the ownership of a company. The marketplace in which stocks are publicly traded is referred to as the stock market or stock exchange, whilst private companies deal directly with investors;
- The stock of a company is sold in units known as shares. This is essentially the specific mechanism or currency by which ownership is acquired and transferred;
- Equity refers to an ownership interest in a company. Shares are an example of equity.
2. The different classes of shares (ordinary and preferred)
Not all shareholders are created equal. In some jurisdictions, there are two different tiers of shares: ordinary shares and preferred shares.
Preferred shares, also known as preferred stock, are a class of ownership in a company that offers a higher claim to the company’s assets and earnings than ordinary shares (common stock).
Holders of preferred shares are paid dividends before ordinary shareholders, often at a fixed rate, whereas dividends for ordinary shareholders are declared by the company depending on its financial performance that year. However, preferred shares usually carry no voting rights.
If a company gets liquidated, holders of preferred shares have a prior claim to the company’s assets compared to ordinary shareholders. However, their claim still comes after the claims of creditors.
It is important that you indicate the right class of share when you are drafting contracts for the issue or transfer of shares.
3. What do your shareholders bring to the table?
If you are a small business owner with substantial decision-making power about who you bring on board as shareholders, it is beneficial to think about what each individual shareholder brings to the table.
Depending on the terms set out in the Shareholders’ Agreement, your shareholders would have a say in making certain key business decisions, such as whether to adopt a proposed business plan or whether to approve a transaction above a certain value.
Just bringing on board one additional shareholder has the potential to change the dynamic of how decisions are made and influence the direction the company takes.
It is helpful to think about shareholders’ contributions in three main buckets:
- Financial. As a small business, your equity investors are a significant source of capital. Think about whether your investors would be willing to step up in times of trouble
- Information. Given that they have an interest in the health and profitability of the company, shareholders can potentially offer crucial information, analysis and advice that may aid management in the running of the company.
- Discipline. The shareholders and managers of the business have a principal-agent relationship, and active shareholders will help ensure that managers do their job well.
In evaluating whether to bring on board a certain shareholder, think about the value that the shareholder could bring. This could be prior business experience may help them make informed decisions on how to cast their votes, or potential introductions they could make that will bring new opportunities.
Related reading: Angel investors vs venture capitalists
4. Proper documentation
After you decide who you want to issue or transfer shares to, it is crucial that you have this all set down in writing so that there is proper documentation for each individual’s shareholding in the company.
Issuing new shares usually involves the following steps:
- Share Subscription Letter, in which the new investor makes a formal application to subscribe for the shares;
- Share Certificate that is issued to the new member after the board of directors has approved the issue of the new shares;
- Deed of Adherence which is a document that indicates that the new shareholder agrees to the the terms of the existing Shareholders’ Agreement, if one already exists;
- Request for Payment of Interest or Dividends that enables the new shareholder to receive any interest or dividends that are due.
Shareholders have the ability to transfer their shares to existing shareholders or third parties by way of a sale of the shares or a gift. This must be done in accordance with the company’s Constitution and any Shareholders’ Agreement.
Transferring existing shares usually involves the following steps:
- The existing shareholder will need to complete an Instrument of Transfer to transfer the legal title of the shares from the existing shareholder to the new shareholder.
- The board of directors must convene a board meeting to approve the transfer of shares to the new shareholder. Alternatively, in place of a board meeting, the directors may pass a written board resolution to do the same.
- The new shareholder should then agree to the terms of the existing Shareholders’ Agreement, if one already exists, by signing a Deed of Adherence.