What are share certificates
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TL;DR — No, not necessary.
Long answer — Paper certificates are mostly a fiction and most early stage companies and their lawyers either ignore or botch the process of issuing them. Per Delaware law (and most states) a company's shares may be "uncertificated" and its books and records kept electronically, but only if specifically set up that way. Doing so significantly cuts the cost, timing, and complexity of issuing founders shares and completing early-stage investment.
Share certificates are a hold-over from the old days before computers, email, or even faxes — at one time there weren't even automobiles or telegraphs. The certificate served as both a proof of ownership and depending on the circumstances a negotiable instrument, like a check at a bank. If you showed up somewhere with a certificate you could sign your shares over on the spot to sell them, and the certificate and news of the transfer would find its way, physically, over land, back to a room where the (paper) books and records of the corporation were kept. I wasn't there and I'm typing this from memory so I may be oversimplifing. If anyone knows the exact story I'd love to hear it!
There's long been a practice of "share escrow" (wink, wink) whereby the company theoretically holds the certificates on behalf of stockholders subject to vesting or other restrictions so that they don't run off and tender unvested shares to just anybody… as if that could ever happen. This gives rise to page after page of needlessly ritualistic language in the founders documents, there because of the inertia of custom, about handling lost certificates, indemnification for lost certificates, closing procedures (which are rarely followed), share registers, right to inspect share registers, where the share registers are kept, legends that may be printed on certificates, assignments separate from certificates, etc.
A barometer of whether people actually print their certificates: in the old days companies had elaborate custom-designed certificates, often with clever detailed etchings. A train company might depict a locomotive or a bridge. Through the 90s every stationery store carried blank certificates in a variety of frilly patterns and colors. We bought two-color certificates and color-coded them: founders got blue and gold, Series A got red and gold, etc. We didn't charge for the paper because, hey, you're paying good money and you're worth the extra five cents a page to us! Today it's hard to find a brick and mortar store that carries blank paper certificates anymore even in San Francisco and Silicon Valley.
The pressure to go paperless came, interestingly, not from startups or technology companies, but from stockbrokers. Beginning in the 1980s, perhaps before, big retail brokerage houses like Charles Schwab would handle their customer accounts by telephone and computer. If you wanted 5,000 shares of Coca Cola you called up your broker, or later, sent a fax or email, or dialed up their trading service on your modem. You could sell the shares that day or the next day if you felt like it, and there was no time or practical reason why they should send you the paper shares. But the law still required paper certificates so there was a massive, expensive operation of printing and warehousing paper
certificates. Eventually, just like the banks, they realized that the paper was unnecessary and, thanks to new laws, started doing everything electronically. Today public companies are far more automated than startups. Also today, Delaware law has swung to the point where it is not legal for a company to issue shares that (like cash or checks) are negotiable by the bearer. The company has to keep the definitive records; the certificate is just a token.
Back to Delaware laws. Although Delaware allows uncertificated shares and electronic books and records, it does not require them and this is not the default. You have to include provisions in the certificate of incorporation and the bylaws. Further, anybody who was ever promised paper certificates has a right to them. As Dana Schultz says, there are notice requirements in California and other states with respect to transfer restrictions. We have a fix for that, but there are still some inconsistent and contradictory laws, and there is little history or case law dealing with that. We're still in the early days of paperless offices. Switching from paper to paper-free, then, involves amending the certificate and bylaws, gaining shareholder (and often investor) approval to do so, paying close attention to the wording of all your documents, and dual-tracking the process until every stockholder has consented to it. It's very expensive custom legal job that, frankly, is not worth it for a legacy company. It's only cost-effective for new companies that are setup right to begin with.
With law firms too, going paperless involves a do-over of all of the legal forms. The legal document sets bouncing around Silicon Valley and throughout the country are still the old version, the ones with dozens of pages of archaic language that few people follow about what you're supposed to do with paper documents, paper books and records, and paper notices sent by (certified) mail to everybody. Whether you hire a big law firm or go to LegalZoom, you'll get old school company documents. So you have a situation where people don't understand and don't regularly follow their corporate formalities. This gives rise to lots of errors. With all due respect to Mike Prozan and David Raynor. you can mess up computer files as badly as paper ones, but I think there's a lot more potential for error with paper, particularly with burdensome requirements that people don't actually follow. Whether print or online, conforming to your corporate formalities and keeping track of who owns all the shares is a question of how good your software is and how well people use it.
It's true that having something tangible makes people feel special and secure. Frankly, I'd rather send each founder and investor a show ticket or a bottle of thank-you commemorative champagne, or a deal trophy for their desk, than a stock certificate. More realistically, we're looking into the software but it's entirely possible to choose a middle ground, where there are electronic share certificates — nice, photoshopped files that can be authenticated and checked against company records, with cool custom company pictures and logos, so if anyone wants to see their shares or show them to someone else they just enter their special code, it appears onscreen and they can print it out for themselves. If anybody has a favorite (non-legacy, open, nonproprietary, SaaS) private company stock management service, send them our way!
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