Back in February, our chairman wrote one of his first blog articles on shares of stock entitled, Demystifying Stock. In it he defines “Stock” and some of the terms commonly associated with stock, like Authorized Shares. Reading his article should give you a better understanding of the definition of stock, but it may still leave you wondering, “How many shares of stock should I authorize for my corporation?” And some of you may still wonder further, “At what par value do I authorize the stock for the corporation?” Just as a quick refresher, Authorized Shares are the total number of shares that a corporation may sell or trade, and are defined at the time of filing the Certificate of Incorporation. When authorizing shares, the corporation must define the quantity, the par value and the classes for the authorized shares.  Though not an exact science, here are some general considerations when deciding how many shares to authorize for a Delaware Corporation.

Quantity – When authorizing shares for a Delaware Corporation, one should consider that the annual Delaware Franchise Taxes will be based on the number of shares; therefore, when possible, it is best to keep the number of authorized shares low.  A good rule of thumb is to authorize only what the corporation will need. Corporations with 5000 or less authorized shares are considered “minimum stock” and will pay the minimum Delaware Franchise tax each year. If you must exceed 5000 authorized shares your corporation will be classified as a “maximum stock”  and you will be afforded the opportunity to recalculate the company’s Franchise Tax using a complicated formula called the “Assumed Par Value Capital Method”  that will consider the company’s gross assets and the number of issued shares at the end of the year.

Par Value and Share Valuation – If you decide that you need more than 5000 authorized shares for your corporation, the Delaware Franchise Tax calculation is no longer a matter of consequence, and now the focus should shift to the par value assigned to the shares. If you must exceed 5000 shares, the next threshold for you to consider is a share valuation of $75,000. Share valuation is simply the number of Authorized Shares multiplied by the Par value. Par value is only relative to the bottom value of the share, and has no bearing on the “market value” or “stock price” of the share.   As with the number of authorized shares, generally it will be better to keep the par value as low as possible because the initial filing fees will be calculated based on the share valuation. “Minimum Stock” Corporations may consider a zero par value, but corporations in excess of 5000 authorized shares will want to assign a par value to the shares to avoid additional filing fees levied by Delaware Division of Corporations. Delaware Law will allow a par value as small as $0.000001, thus making it very easy to manipulate your company’s share valuation to remain below the $75,000 threshold. For example, if you decide you need 1,000,000 authorized shares you can assign a par value of $0.001 which will result in a share valuation (1,000,000 shares x $0.001 par value) of $1,000. Because the share valuation is less the $75,000, the corporation will not experience any additional filing fees at the time of incorporation.

Classes of Stock – Though the classes of shares have no direct influence on the Delaware Franchise Tax, it is still important to mention.  For most corporations the share class will be “Common” but the scope of Authorized Shares includes all classes (i.e. Common and Preferred). Therefore, it is important to remember that when you are considering the quantity of authorized shares or calculating the share valuation that the authorized shares are all shares combined, both common and preferred.

Every Delaware General Corporation must have one class of common stock, but it can have more than one class of stock, with different rules for the different classes. The most popular second class of stock is called “preferred stock” because it contains terms that are preferred over the rights of common stockholders. Delaware’s brand of preferred stock is so powerful and flexible a business tool, it is commonly called “Blank Check Preferred.”

Common stock has two characteristics that are written in the law. They are mandatory. The first is that every share of common stock carries one vote. If you own 100 shares you have 100 votes to vote on all matters presented at Stockholder meetings.  The second is the right to your pro-rata share of any dividends issued by the Directors to the common stockholders. If the total dividend is $1,000,000 and you own ten percent of the total outstanding shares, you’re entitled to 10% of the million dollars. Common shareholders OWN the company and they have a right to share in the profits. That’s fair.

But the Board of Directors, with shareholder approval, can authorize a second class of “preferred stock” that can be issued by the Board to attract capital or top people or strategic alliances. The total number of shares of preferred stock may be split into any number of different “series” of the preferred stock, each series having its own separate terms. For example, the company may be created with 1,000,000 shares of common stock and 100,000 shares of preferred stock. The Board can designate that the preferred be split into ten series numbered 1 through 10 of 10,000 shares each and that the terms of each series can be negotiated separately and are independent of the other series.

What’s preferred about preferred stock? First, voting rights. Common shareholders get one vote per share, but you can give one or more series of the preferred stock super voting power like two votes per share, or ten or 100 or 1,000 votes per share. Why do this? Let’s say you’re creating a series of preferred to option out to key personnel. You can offer company insiders voting power this way. Or let’s say you are attracting capital from a key shareholder that already owns a big percentage of your common stock and you don’t want him to take control. So you create a series of preferred stock with NO voting rights, but a guaranteed 10% dividend paid quarterly. Your investor might be enticed to invest more money but give up any increased voting rights. Or let’s say you are raising capital and you’ve sold 45% of your stock. Once you sell more than 50% of the company you lose control. So what do you do? Bring out a series of preferred stock designated as Founder’s Stock in which the 10,000 shares have 100 votes per share. Have the Board of Directors issue the whole 10,000 shares to you. Now you can sell more of the common stock to investors and still keep control of the company. These maneuvers are sophisticated tricks and should be undertaken with the assistance of a really good corporate lawyer, obviously.

Secondly, preferred stock can have a preferred dividend over common stock. Preferred stockholders can be guaranteed a certain dividend per share ($1.00 per share, for example) or a dividend based on a business calculation that suits the deal, (x% of increase in net profits, for example). These dividends can be guaranteed, cumulative, and convertible to common stock if the deal makers agree on it and a good lawyer drafts it up right. Preferred dividends are usually paid before the common stockholders see any return.

Third, preferred stock can hold a security interest in a company-owned asset. This can include a patent, real estate, a major piece of equipment or any other company asset. Let’s say your company owns a patent that is much more valuable when combined with another patent that you don’t own. Negotiating with the owner of that patent might be a breeze if you could design a series of preferred stock with no voting rights but a security interest in your patent and a royalty from sales of the products that contain their patent.  (Or whatever you can dream up). Or let’s say the company is desperate for an influx of cash. Bankruptcy is the next step if a deal isn’t put together in time to save the company. No one will buy your common stock if you’re about to go bankrupt, but someone might invest if you gave them a security interest in the assets that will be freed up if the company goes bankrupt. I hope you never need to use that technique, but if you find yourself in that position you’ll be glad you have a Delaware corporation with blank check preferred stock.

If you’re just about to form your Delaware General Corporation and expect to sell stock in the company to raise money, it would be a good idea to consider getting the preferred stock right from the start by including it in the Certificate of Incorporation.  That way you won’t need the shareholders approval to authorize it when the time comes that you need it. The Directors will be able to issue the stock in the best interests of the company without the necessity of getting shareholder approval. If you already run a Delaware General Corporation you will need shareholder approval to amend the Certificate of Incorporation authorizing the preferred shares. If you control the common stock now, it would be a good idea to authorize this class of stock at your next shareholder meeting so that when you need it, it’ll be there.

Every single one of the fortune 500 companies is a General Corporation. Most of them are Delaware General Corporations, of course but there are NO LLCs, not even one on the fortune 500, or the New York Stock Exchange or the NASDAQ. Stock exchanges are for Stock companies! And that’s why the General Corporation is often referred to as a “Stock Company”. It is created with stock that can be sold on the open market.

The General Corporation is an enlightened creation by 19th Century American lawyers to allow for, and provide financing for the growth of the era’s biggest businesses – Standard Oil, DuPont, The Railroads, etc. – which were all outgrowing their family partnership or personally owned businesses at the time. The problem was at that time they had no options.

Before 1875, when Delaware passed one of the first General Corporation Laws, the state legislature had to approve a bill to form a “public corporation”. Libraries and banks were examples of the very few corporations in existence. Until the smartest lawyers in New York and New Jersey got together and wrote a law for the State of New Jersey allowing for a corporation that could be used for business purposes. It was to be available to the public “generally”; not just those who could get a law passed. The term “General” was to be defined as available to anyone who could follow the legal procedure the State prescribes to form such an entity. In other words, ANYONE could form a General Corporation simply by making an application that contains the required information to the proper government agency and is accompanied by the correct fee for filing the document. The filing by the Secretary of State’s Office is, in a real sense, the “birth” of the entity.

Once the State of New Jersey enacted the very first law allowing for the creation of General Corporations all of the biggest companies in the U.S. formed a New Jersey General Corporation, including the DuPont Company, which was indigenous to Delaware, a much smaller state than New Jersey, but right next door. Delaware reacted.

Using it’s smallness as its strength; the State of Delaware went to the DuPonts in the early 1900’s and offered to work with them to make fair and favorable laws to govern corporations if they would re-incorporate in Delaware. The deal worked. At the same time, New Jersey passed a series of laws that restricted corporations and increased their tax rates. Soon, all the big companies followed the DuPonts to Delaware and Delaware became the Corporate Capitol of the U.S.A.

At the same time, Delaware’s Court of Chancery was rapidly becoming the premier business court in the country, with almost 100 years of case law. In the final analysis, it is the Court of Chancery that explains why 63% of the Fortune 500 are domiciled in Delaware. Although these giant companies may they have no physical presence in Delaware, they are “domiciled” there by virtue of their choice.

Conveniently, The General Corporation structure works just as well for small innovative companies who need to raise money to get the enterprise going. If you plan to raise money by selling stock to get your company quickly off the ground and growing the Delaware General Corporation is the entity of choice.

Next time we’ll go into the structure of a General Corporation.

This blog category will help you understand all the benefits of a General Corporation as time goes on. We invite you to join the conversation and leave a question or a comment.