Understanding Stock Certificates

Stock certificates confirm a person or entity really owns shares. They are either pieces of paper or electronic files (read our full blog post on this here).  However, for things like equity financings, even though stock certificates are often a victim of procrastination and pushed off ‘til the investors ask, most investors will still expect their stock certificates. This article outlines what the point of stock certificates is and why investors still ask companies for them.

Making Sure Everyone’s on the Same Page

Investors often use stock certificates to confirm that everyone’s on the same page with (1) who holds the shares and (2) the number of shares they hold.

You might be asking yourself, isn’t checking just a formality? How could there be mistakes on these points? Unfortunately, these mistakes are an all-too-frequent occurrence. Stock certificates surface issues such as: the startup issued the shares to Acme Venture Capital Firm, when it really should have been Acme Venture Capital Firm Fund II L.P. The VCs get the stock certificates, realize the mistake, and demand that the mistake be corrected. The startup updates their cap table accordingly so their records are correct. Stock certificates also make it easy to check the number of shares, which can have typos that otherwise go unnoticed.

NOTE: Before stock certificates can be created, there’s yet another safeguard to make sure everyone is on the same page. The board signs a board consent approving the form of stock certificate, which confirms they see what template is being used for the stock certificates and they’re okay with it. This also means that any future changes to the stock certificate template have to be approved by the board.  

Tradition

Most investment firms ask for a copy of the electronic stock certificates, because that’s what they’ve always done. Traditional practices of the investment firm dictate that the firm asks for a stock certificate before they put the investment on its books. These traditional practices are memorialized in checklists that are rarely updated or scrutinized, so even though more and more startups have built into their documents that their shares can be uncertificated, investors still ask for certificates.

What’s included on a stock certificate?

• Certificate Number: Each certificate has its own certificate number, issued by the company, which allows it to be tracked.
• Company Name: The company whose stock you now own.
• Stock Class: This indicates the type of stock this certificate represents (Common or Preferred).
• Par Value Amount: Par value is the nominal value, or face value, of the stock.
• Number of Shares: The amount of shares this certificate represents.
• Stock Owner Name: Identifying the owner of the stock.
• Date: Indicates the day on which the stock certificate was issued.
• Signature: Corporate officers of the company must sign the certificates.
• Stock legends: Required notices to inform the shareholder that they must comply with the applicable laws and company agreements restricting the sale, transfer, or pledge of the shares.

Stock Certificate Legends Are Useful

The legends on the back of the stock certificate allow people with no knowledge of how or why the shares were issued to inform themselves quickly of whether the shares are registered with the SEC and if there are restrictions on transfer of the shares.

Looking at the stock certificates will also give a person a handle on the documents and contractual agreements surrounding the share issuance. As an example, did Bob get 30,000 shares through an equity financing that had a right of first refusal or an initial founder share grant with a founders agreement? The legends should tell you.

Examples of Stock Certificate Legends

For private startups. there’s always the standard 1933 legend, which warns that the shares haven’t been registered with the SEC, so they can’t be transferred unless they are (a) registered under relevant state/federal rules, or (b) they fall under exceptions that say they can be transferred without registration. This is standard on every stock certificate, and just warns everyone of what every securities lawyer already knows is true of every private stock issuance.  

The other legends are more interesting, and tell a larger story. Just by reading the legends of one stock certificate, you can start to piece together the story of the shares. Take the example legends in the picture below:

• The first paragraph is the standard 1933 legend that’s present on every private company stock certificate, and it is unremarkable.
• The second legend tells us that the shares are subject to whatever’s written in the Stockholder Agreement. If you’re looking for the Stockholder Agreement to see what’s written there, it tells you to write to the company and request it, and the company will happily provide it (for free!).
• The third legend states that there is a Stock Restriction Agreement that these shares are subject to. It says that we may request this document from the company as well.

In summary, we know these shares are subject to a Stockholder Agreement and a Stock Restriction Agreement. These sound like founders shares, which are shares that are commonly subject to a founders agreement (aka stockholders agreement), and also a restricted stock agreement, e.g., subject to vesting and other conditions.

Keep in mind that these legends are a snapshot in time as of the date the stock certificate is created, which means they might become slightly out of date—for example, they might refer to a Stockholder Agreement when in fact it has been replaced by a right of first refusal and Co-Sale Agreement and/or Voting Agreement. But it will at least give the beginning of the paper trail, and you can trace it from there.

Knowing all about stock certificates—from what the legends on the back mean to what key pieces of information to check on the front—will be useful in many circumstances. You’ll be able to better manage the creation of stock certificates. You’ll know why on earth investors are asking for stock certificates after an equity financing. You’ll be better able to proofread your own stock certificates and make sure they’re correct. Go forth with this newfound knowledge and manage your stock certificates like a boss!

Did you know that Fidelity can generate electronic stock certificates for your company, with standard and customizable stock legends?