PAPER STOCK CERTIFICATES ARE PRETTY
If you bought shares of stock in a public company in the early 1900s, you received your shares in the form of paper stock certificates. Many certificates had elaborate designs, some were engraved and others were individually signed by company executives. Many certificates were so attractive, people framed and hung them on their walls for decoration and as a display of status or wealth.
While they might be pretty to look at, paper stock certificates are pretty in many other ways, too. For companies, they are pretty expensive to maintain, pretty laborious to manage, pretty onerous to track, pretty burdensome to replace and pretty tough to audit. For shareholders, they are pretty hard to track, pretty challenging to value and pretty difficult to use.
DISADVANTAGES TO COMPANIES
One of the primary reasons that most public companies have stopped issuing paper certificates is to save money. A large, public company might need an entire team dedicated to nothing but managing a paper stock certificate equity system. It's a big expense for the company, and it's not an expense that adds much value.
Any paper-based, manual system is laborious to administer, and paper-based stock certificate programs are no exception. Every time there is a transaction, the paper certificates need to be signed and mailed to the company. No transaction can proceed without the physical paper certificates in hand. It makes regular, standard transactions very slow and labor-intensive, and it can be strenuous on shareholder relationships. Just imagine the work involved in a merger or acquisition, when all paper shares from one company need to be canceled and new paper shares need to be issued.
Because many shareholders treat paper certificates like money, they can be very difficult for the company to keep track of. For example, someone might bequeath their paper shares to an heir without notifying the company. When the heir decides to sell the stock, she believes that holding the paper certificates is proof that she owns the shares. The company, however, doesn't know anything about her because the shares were never properly transferred. It all adds up to a tremendous amount of administrative work to verify wills and identities and complete the transfer of shares -- and to do it all without irritating the shareholder.
Unfortunately, it's not at all unusual for paper certificates to get lost or stolen. When that happens, it creates a great deal of work for both the company and the shareholder. The company has to track down the old shares, verify the owner, make sure they weren't cashed, put a stop on the paper certificates and then issue new certificates. Placing a stop on the paper certificates, however, doesn't guarantee that they won't be cashed in the future. This creates a liability for the company if someone manages to cash the lost or stolen shares despite the stop order.
DISADVANTAGES TO SHAREHOLDERS
Paper stock certificates are hard to keep track of. For example, it's very easy for anyone to misplace a piece of paper when they have moved four times since receiving it 20 years ago. Even worse, an employee who regularly receives new paper certificates might misfile or misplace a few certificates and never even realize it.
When a shareholder has paper certificates that are lost or stolen, getting replacements is not a simple process even when the shareholder knows which certificates are missing. It's much harder when the shareholder knows that some are missing, but doesn't know which ones. Because of the liability it creates when a company replaces paper certificates, shareholders might have to purchase an indemnity bond to protect the company. This usually costs around one percent to two percent of the total value of the shares that are being replaced.
With paper certificates, it's a manual process for any shareholder to calculate what he owns and how much it's worth. It's even more difficult when some of the shares are subject to vesting and if the shareholder also has stock options. Many shareholders probably create a spreadsheet and enter the information on the shares they currently have to do the calculations. As they receive new paper certificates in the mail, they add these shares to their spreadsheet.
Shareholders might find it difficult to quickly sell stock that's issued on paper certificates. Before the company can make any transaction, the shareholder has to sign and mail the paper certificates to the company. If both happen to be located in the same city, the transaction might be able to happen more quickly. Otherwise, it might have to wait until the next day when an overnight mail service can deliver the paper certificates.
These are just some of the reasons why paper stock certificates are laborious, time-consuming and expensive for companies and shareholders. That's why some public companies began transitioning away from paper certificates back in the 1980s, and most public companies have stopped issuing paper certificates entirely. If you buy shares of Disney stock today, you won't get a fancy Disney paper stock certificate in the mail because they stopped doing that in 2013. For another $50 or so, you can get a piece of paper that's reminiscent of old paper stock certificates with illustrations of popular Disney characters, but that's strictly a souvenir and has absolutely no monetary value.
As a company executive, if you were given the choice of using a paper-based manual system or an electronic automated system, which would you choose? Probably the latter. Yet curiously, even some of the most cutting-edge high-tech startups issue paper-based stock certificates. The same difficulties and expenses associated with a paper-based stock certificate program that apply to public companies apply equally to private companies. So it leaves many people scratching their heads when a new private company begins its equity program by issuing paper shares.
Private companies should learn from the experiences of public companies and follow their examples. If a private company has already issued paper stock certificates, it should transition now to electronic shares. A private company that hasn't issued any shares yet should adopt an electronic process exclusively, not a manual paper-based process.