Shareholders Agreement 101: The terms and conditions of issuing new shares in a company(Part 6 of 10)
By Joanne Hue, published: 2023-02-17
Companies allot shares as one of the main ways to raise new finance. Share allotment is different from the transfer of shares. The former stream new money into the company and provides funds for the expansion of the business, allowing it to advance.
The new issue of shares equates rise in company stocks. An initial public offering or (IPO), allows investors to purchase shares of a previously privately owned company. During the process of issuing new shares, bonds or convertible securities may also be dispersed. This allows the company to increase its debt capital.
Prior to investing, investors should adopt caution of popularity surrounding the new issue of IPO as it may or may not be advantageous to the investor. If a company that is already public, wishes to issue new shares, it may do so via secondary offerings.
When should a company issue shares?
Typically, a company will issue new shares if they require finance to boost growth. Shares are usually issued under the following circumstances:
- Growth of the Company: Companies reach out to investors when they are intending o expand it. These investors may be family and friends, venture capital firms, or angel investors. In the return of funds, the investor is given part ownership of the company.
- Expansion of Sole Trader: When sole traders decide to onboard co-owners in the business, they do so by issuing new shares for the new co-owner. Expanding from a sole trade may be helpful in providing extra funds to your business and incentivizing a prospective co-owner.
- Option Holders: An option holder can issue new shares, They are the individuals who have the right to buy or sell shares in your company.
- Trigger Event: Agreements such as convertible notes and SAFEs, require a company to issue shares during a trigger event. This is agreed upon in exchange for funds. Usually, a close of a capital rise is known as a trigger event. In the occurrence of a trigger event, a company is bound to issue shares to its investors with whom it has conducted a prior agreement.
How Can You Issue Shares?
There are four stages to the issuance of shares:
1. Assess the Capital
Before issuing a share, a company needs to assess the amount of capital they require to grow its business. They then have the liberty to decide when=ther they require the issuance of shares for their upcoming expansion project.
Since the issuance of shares impacts older shareholders by diluting their ownership and impacting their voting power, companies need to notify their existing shareholders about the issuance of new shares. This notification is crucial because shareholders will have the primary right to purchase these shares. After shareholders make a decision on whether to purchase the newly issued shares, external investors can purchase the shares. This right of existing shareholders is known as the right of first refusal. If shareholders waive their right of first refusal, a company should document it in its minutes.
Only after existent shareholders waive their rights, a company may offer its newly issued shares to a third-party investor.
Negotiations are a crucial part of issuing new shares. A company will have to negotiate with the new shareholder on commercial discussions. A term sheet is typically used for negotiation when capital is being raised. A term sheet is a non-binding document. It sets out terms such as price per share and the total amount the company is seeking to raise.
When the terms of purchase are agreed upon, they should be formalized through legally binding agreements. Then, a subscription document is used to set out the terms of the investment and a shareholders agreement is used to govern the relationship between the shareholders.
Registering shares and shareholders
Irrespective of the route taken by the company to issue new shares in the company, they will usually do so when securities are offered for sale. Shares can be issued for cash or at par.
The first step of issuing a share is issuing a prospectus. When a public company plans or raises its capital by allowing public funding, the invitation for the public to invest is done through a document known as a prospectus. The prospectus provides brief information about the company, its records, the reason behind the issuance of new shares, the opening and closing date for the issue, the payment required during the time of allotment, the name of the bank for deposit of application money and a minimum number of shares for the acceptance of the application.
The second step to issuing new shares is the reception of applications. The public will apply for the purchase of shares after reading the prospectus. Inventors will have to deposit the money in the specified bank and fill out the application form. The company is not allowed to withdraw this amount until they acquire the certificate to commence business. Likewise, a company will also have to acquire a minimum subscription to the newly issued share in order to withdraw the amount. The payable amount on the application cannot be less than five percent of the nominal amount.
Finally, the company allots shares or accepts applications for investment. The shareholder is provided with an Allotment letter. The letter informs the holder of the amount to be called during the time of allotment. The final decision concerning the allotment of shares is taken by the company’s board of directors.
A Company issue shares in order to expand its business. Existent shareholders can influence this decision. Prior to allowing third-party investors to purchase newly issued shares, the terms of the shareholder’s agreement provides existing shareholders to purchase the newly issued shares. Likewise, if your company has signed and provided convertible notes to its inventors or holds a SAFE agreement, then the company has the obligation to issue them shares in case of a trigger event.
You may also like:
- Shareholders Agreement 101: Rights and Responsibilities(Part 1 of 10)
- Shareholders Agreement 101: Terms and Conditions of Transferring Shares(Part 2 of 10)
- Shareholders Agreement 101: Resolving Disputes Among Shareholders (Part 3 of 10)
- Shareholders Agreement 101: Defining The Voting Rights of Shareholders (Part 4 of 10)
- Shareholders Agreement 101: The Roles and Responsibilities of the Board of Directors (Part 5 of 10)
- Issue New Shares Template
- How to Set up a shareholders’ agreement