Is my company required to issue paper stock certificates?

December 4, 2017 - Posted by: admin - In category:

taxes - No Responses

No. There are electronic alternatives to paper stock certificates.

The first step is to determine what is written in the articles of incorporation, certificate of formation or other foundational documents of your company. If your business entity has been in existence for more than a year or two, it is almost certain that the relevant legal papers mandate paper stock or membership unit certificates. However, the concept of paper stock certificates and unit certificates is as outdated as typewriters and should be discontinued in almost all instances.  If corporate documents currently require paper certificates, such documents can be amended to permit electronic ledgers.

Electronic stock ledgers, also known as a Direct Registration System (DRS), are better and “modern” ways to track ownership of business entities.  Large public companies switched over to electronic ledgers many years ago.  For example, have you ever seen a paper stock certificate for Microsoft, Google or Apple?  No, likely because no such things ever existed (especially in the case of Google) and electronic ledger entries have long-since replaced any such paper stock certificates for Apple or Microsoft with the respective stock clearinghouse custodians.  If this computerized ledger method of tracking company ownership works for a multi-billion dollar international enterprise, why wouldn’t it work for your small to medium-sized or even large business?  Switching over (in cases where paper certificates were issued previously) or starting with electronic stock ledgers (in the case of new companies) can be a less expensive and much more reliable and convenient method of evidencing and tracking business ownership.

How does a company go about adopting an electronic ledger system?  There are many internet resources about this subject and vendors that specialize in offering these types of services.  You can obtain the tools to keep your electronic stock ledger or have your accountant do so, or you can retain a company like Capshare to do it for you.  There will be pros and cons to either approach.  But either way, one of those two options will be the best answer for just about any company. It is difficult to conceive of a situation where retaining the old paper certificate system would be the best approach (from any perspective)–just as it is hard to imagine why anyone would stick with a typewriter these days.

Paper stock certificates can get lost, damaged or stolen, among other potential challenges and issues.  Are there problems that can arise using electronic stock ledgers? Yes, of course.  Nothing is a panacea. Even so, using a computerized stock ledger, instead of paper certificates, does away with many of the potential problems associated with paper securities.  For example, if company ownership is verified through one central electronic ledger kept with other elements of the company’s computerized books and records, there is no concern that someone is going to lose their paper stock certificate–as all that matters is what is contained in the electronic ledger held at company headquarters.  If we trust the company to keep track of income, profits, expenses, inventory, research and development, patents and a host of other “important stuff” at its headquarters and/or in the electronic files of its professional advisors, why would there be any concern about the company (or its advisors) also serving as a repository for company ownership held via an electronic share ledger?

Let’s pause here to note the very important fact that in order for a company to make the switch from paper to electronic stock ledger, the legal documents governing the company’s ownership and operations must provide for the same.  This means in most instances that the articles of incorporation and bylaws (for a corporation) or the certificate of formation and operating agreement (for an LLC) will need to be reviewed by legal counsel and amended in a manner that accommodates this change.  Of course, if we are dealing with a new company as it is being formed (i.e., if we are smart enough to consider this at the beginning of business operations), such legal provisions can be built into the organization documents on the front end.  For example, I don’t recall forming an LLC or a corporation in the past decade where I have not included the option for the company to use the electronic ledger method of tracking ownership.

Are there potential negatives to foregoing the paper stock certificate method in favor of using an electronic stock ledger? To me, that is like asking if there are reasons to hang onto a typewriter instead of using a computer.  But my views aside, Capshare has written an excellent article on potential concerns about using an electronic ledger and the responses to such matters.  While I recognize that Capshare is biased in its views (as a company which provides electronic ledger services), the article nevertheless seems well-reasoned. CLICK HERE TO READ THAT ARTICLE.

In summary, please remember that you are not required to use the traditional paper certificate method to evidence ownership of your company.  That method is very much outdated, and there seem to be few reasons to stay with that approach.  Rather, as with so many other things in our world today, electronic alternatives offer significant advantages for the company, its management, and ownership, whether consisting of one person or one thousand or more people.  If you use a computer or a smart phone, you are most likely ready to use electronic share ledgers in place of paper share certificates.

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