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Seven Things Everyone Entrepreneur Should Know About Stock

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Some entrepreneurs carry on about corporate stock like teenagers speak about sex: They know "the lingo" but have no clue how anything really works. So it's important to have "the talk" with new business owners before they embarrass themselves or start doing things that get them into trouble later. Here are seven key concepts about stock every entrepreneur should know.

  • Common Stock. All corporations offer common stock. Common shareholders vote at meetings and receive dividends when they're declared. It's different than preferred stock, which often entitles owners to receive dividends in certain situations but with no voting rights. Except in subchapter S corporations, which can only offer one class of stock, you can create as many different classes with whatever rights you want. However, we recommend you Keep It Simple! Don't create multiple classes unless and until it becomes necessary.
  • Voting Rights. The shareholders make key corporate decisions (e.g., choosing directors) by voting at meetings. All owners are entitled to be notified when meetings are called. They vote their shares to make key decisions. The more stock a holder owns in relation to all outstanding shares, the more control she has over the corporation. That's why percentage of ownership is a lot more important than the number of shares held.
  • Dividends. When a corporation declares a dividend, it's sharing some of the profits with the shareholders. They're paid in cash or stock based on the number of shares each owner holds.
  • Vesting. Stock vests when it's accrued over time. Vesting is usually used to entice employees to stay with the company. A new employee may be promised a certain number of shares paid out in tranches. For example, John may be entitled to 12,000 shares as part of his salary and wages. But to keep John from jumping ship early, he only receives 1,000 of those shares per month. If John quits or is fired for cause before the year ends, he may forfeit some or all of the accrued shares.
  • Cliff. A cliff is a date certain after which a shareholder can keep accrued shares even if the vesting period hasn't ended. For example, Susan is promised 36,000 shares over three years. If there's a one-year cliff, after the first 12 months she keeps the stock she's accrued even if she doesn't remain employed for the entire three years.
  • Par Value. Par value is a fancy way of saying "price per share". You don't have to declare a par value at formation, and the better practice is not to have one unless you absolutely must. Arbitrary assignment of par value can complicate future transactions.
  • Dilution. When a corporation issues new shares, the value of an individual share decreases. If Rob owns 100 shares out of 1,000 issued, he owns 10% of the company. If the company distributes an additional 1,000 shares and Rob doesn't get any, he now holds 100 shares of 2,000 issued, or 5%. That's dilution. Some corporations offer preemptory rights giving owners like Rob the right to buy enough of the newly issued shares so that his ownership interest stays the same.
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