The reason for paper stock certificates is to ensure accurate, indisputable evidence of shareholder ownership. While most companies still issue traditional paper stock certificates, the truth is that they’re not necessary.
In fact, public traded companies have been using the Direct Registration System (DRS), ditching physical certificates several decades ago. DRS allows investors to elect having their securities registered directly on an issuer’s books. At the heart of the system is ensuring shareholder access to their securities information.
Privately held companies can also use DRS and issue e-certificates. However, before doing so, it’s advisable to check the laws of the state of incorporation since state corporate law varies. For example, California has very specific notice requirements; and while Delaware enables companies to issue e-certificates, it is not requirement.
Startups wanting to issue e-certificates need to incorporate relevant provisions into their operating agreement or bylaws, and ensure general compliance with state corporate law. If your company has already incorporated, but didn’t include provisions to address the issuance of e-certificates, then you need a board resolution to issue uncertificated shares. Additionally, you’ll need to amend your bylaws to reflect the change.
In smaller companies, corporate formalities might be easily overlooked, so it’s vital to your compliance to enlist competent legal counsel to help you navigate through the requirements. Also, engaging an attorney can save you money in the long term since there can be tax and other regulatory implications – whether you’re going paperless or relying on physical certificates.
DRS can certainly save a lot of time and money, but you really should consult a lawyer to help you evaluate what makes the most sense for your business model. You can also take a look at the SEC’s info sheet for investors that describes advantages and disadvantages of each type of registration from the investor’s perspective.