Key Takeaways

  • Private companies can issue stock without going public, using methods like private placements or limited partnerships.
  • Stock issued by private companies is typically less liquid and subject to transfer restrictions and valuation challenges.
  • Employees may receive stock through equity compensation, including stock options or restricted stock units.
  • Selling private company stock is often complicated, involving company approval, buyback provisions, or secondary markets.
  • Ownership in a private company can offer high returns but also carries significant risks, such as illiquidity and limited financial transparency.
  • You can find experienced legal counsel on UpCounsel to assist with private company stock issuance or transactions.

Can a private company issue stock? Private companies can issue stock and have shareholders, but they do not trade on public exchanges and aren't held to the Securities and Exchange Commission's (SEC) filing requirements for public companies.

What Is a Private Company?

Private companies, or privately held companies, including millions of individually owned businesses in the U.S. In fact, all companies in the U.S. begin as privately held companies.

There are five types of private companies, all of which have different rules for shareholders, assets, liabilities, and taxation.

  • Sole proprietorships are held by one individual owner, including all assets, liabilities, and financial obligations.
  • Partnerships are held by at least two owners, including all assets, liabilities, and financial obligations.
  • Limited Liability Corporations (LLCs) are held by multiple owners who share ownership and have limited liability without being required to incorporate.
  • S Corporations are held by no more than 100 shareholders and aren't taxed on their profits.
  • C Corporations are held by an unlimited number of shareholders but are subject to double taxation.

A private company can issue stock and have shareholders. It's issued without undertaking the high costs of an initial public offering (IPO). Some companies stay private because IPOs are expensive to set up, with fees owed to the SEC, Financial Industry Regulatory Authority (FINRA), and stock exchange listings, among others. Some may also stay private to keep family ownership.

Why Companies Choose to Stay Private

Many private companies opt not to go public for strategic, financial, or operational reasons. Remaining privately held can help founders retain control over decision-making and avoid the regulatory scrutiny and disclosure requirements imposed by the Securities and Exchange Commission (SEC). Here are some common reasons businesses choose to stay private:

  • Preservation of control: Owners maintain tighter control over business operations and long-term vision without answering to public shareholders.
  • Lower costs: Avoiding the legal, compliance, and underwriting fees associated with an IPO can result in significant cost savings.
  • Operational flexibility: Private companies are not bound by quarterly earnings reports and can take a longer-term view on growth.
  • Confidentiality: Private status allows companies to keep financial details and strategies out of the public eye, which may be advantageous in competitive industries.

Issuing Private Stock in Your Company

Private companies can raise money using bank loans and some equity funding, but private stock offerings are an alternative means of equity financing. These offerings are attractive because they offer more control than IPOs. Issuing stock in your privately held company is a proven way to raise capital, but you also give up sole ownership to your investors.

To offer private stock, the first step is deciding the value of each share. The value of private shares is difficult to determine because private companies aren't required to release financial statements and report annual reports to shareholders on a regular schedule.

The best way to figure out the value is by obtaining an independent business valuation using a reputable business valuation company. Getting a second valuation from another company allows you to compare values.

After deciding the value of each share, you must choose the type of private stock to offer:

  • Private placement offerings, also known as Regulation D, limit a company to raising less than $1 million. There are also rules about the number and type of investors allowed in the offering.
  • Limited partnership offerings are only used by companies organized as limited partnerships. C or S corporations can't use this offering type.
  • Selling small corporate offerings to an unlimited number of investors is possible. This offering also allows a private company to use marketing tools to look for investors.

If an investor chooses to sell their shares, they may have difficulty finding buyers for their shares because private companies aren't listed on an exchange. If they do secure a buyer, the sale is subject to SEC regulations even though it is for a privately held company. Some private companies offer buyback programs to their investors, enabling them to sell their shares back to the issuing company.

Selling Private Company Stock

Selling stock in a private company is not as simple as placing a trade on the stock market. Instead, there are several routes that shareholders may consider, all subject to restrictions:

  • Company buybacks: Some companies have repurchase programs to buy back employee or investor shares at pre-determined intervals or events.
  • Secondary markets: Platforms like Forge or EquityZen provide private shareholders a way to sell equity, often requiring company approval.
  • Direct private sales: An individual may sell to another investor, but this usually requires board approval and adherence to transfer restrictions.
  • Exit events: A sale of the company, merger, or IPO may provide a liquidity opportunity for shareholders to sell or convert their shares.

It's critical to review the shareholder agreement, stock option plan, and any company policies related to share transfers to fully understand your options.

How Employees Receive Private Company Stock

Private companies frequently use stock as part of compensation packages to attract and retain talent. The most common equity compensation types include:

  • Incentive Stock Options (ISOs): Allow employees to purchase shares at a set price after a vesting period, often with favorable tax treatment.
  • Non-Qualified Stock Options (NSOs): Similar to ISOs, but with different tax implications and typically offered to non-employees such as contractors or board members.
  • Restricted Stock Units (RSUs): Promise employees shares upon meeting certain milestones, such as length of employment or performance goals.
  • Phantom stock: Provides the financial benefits of stock ownership without actual equity, often tied to company performance or future events.

While these incentives can offer significant upside, employees should understand the potential downsides, including taxation and the difficulty of selling shares prior to a liquidity event.

Risks and Considerations of Private Company Stock

Issuing private company stock carries both benefits and risks for companies and shareholders. It is crucial to understand these risks before issuing or investing:

  • Lack of liquidity: Unlike publicly traded stocks, private shares cannot easily be bought or sold. This makes it challenging for investors to cash out.
  • Valuation uncertainty: Without a public market, determining the value of private company stock is complex and often subjective.
  • Limited financial transparency: Private companies are not required to disclose financial performance regularly, leaving shareholders with less insight.
  • Dilution risk: As more stock is issued, early shareholders may experience dilution of their ownership percentage.
  • Transfer restrictions: Company bylaws or shareholder agreements often impose restrictions on transferring or selling shares without board approval.
  • Exit risk: Investors may have to wait for a liquidity event, such as an acquisition or IPO, to realize any return on investment.

For these reasons, it's essential to consult a legal or financial advisor when considering issuing or purchasing private company stock.

Issuing Uncertificated Shares

Like public companies, many private companies have replaced paper stock certificates with a Direct Registration System (DRS), which registers shares electronically without issuing a physical certificate to serve as evidence of ownership.

Depending on where the company incorporated, there are several advantages to switching to direct registered, or uncertificated, shares.

  • Companies don't need to issue stock certificates and get signatures from recipients as proof of receipt. Instead, an email to the shareholder provides written notice containing all the relevant information.
  • Because the shareholders can't sell or transfer their certificates without the company's knowledge, the private company can act as their own transfer agent.
  • Uncertificated shares are easily recorded, documented, and verified with software.
  • Some companies allow shareholders to turn in their hard copy certificates and replace them with uncertificated shares. However, if a company chooses to skip that step, most DRS software allows companies to track existing certificates using the same system.

Tax Implications of Private Company Stock

Tax treatment of private company stock can be complex, and it varies depending on how the stock is acquired and what type it is:

  • ISOs: May qualify for favorable capital gains treatment if holding period requirements are met, but early exercise and AMT (alternative minimum tax) implications must be considered.
  • NSOs: Typically taxed as ordinary income when exercised based on the difference between the exercise price and fair market value.
  • RSUs: Taxable as ordinary income when they vest, and potentially again upon sale depending on appreciation.
  • 83(b) election: Allows employees to pay taxes upfront on restricted stock, which can result in tax savings if the stock appreciates.

Understanding the tax consequences before exercising options or accepting stock grants is crucial. A tax advisor or legal professional can provide guidance based on your specific circumstances.

Frequently Asked Questions

1. Can private company stock be sold? Yes, but it is subject to transfer restrictions, company approval, and often limited to specific events or private sales.

2. How do I value stock in a private company? An independent business valuation is the most accurate method. Factors like revenue, earnings, and industry comparisons are used.

3. Is private company stock a good investment? It can offer high returns, especially in startups, but comes with high risks, illiquidity, and less transparency.

4. What happens to my stock if the company goes public? Private shares typically convert to public shares during an IPO, often unlocking new liquidity and valuation opportunities.

5. Can I give private company stock to employees or advisors? Yes. Many companies use stock options, RSUs, or other equity plans to incentivize employees and consultants.

If you need help with a private company issuing stock, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.