Issuance of Preferred Stock in Family Businesses to Shareholders Who Actively Participate in the Business
A family businesses is generally defined as any business in which members of a family own a majority of the shares or control the company. In some family businesses, some family members keep on running the business, while others pursue other career paths. Fairly dividing the interest in a family business between actively-involved shareholders and those non-participating family members can be tricky. Corporate law, fortunately, provides a near-infinite range of possibilities for ensuring that active family members can continue to run the business while inactive members can continue to receive income. Creating classes of preferred stock is one option, although it carries certain risks.
Ownership of a corporation is represented as shares of stock. A corporation's board of directors can issue shares in accordance with the corporation's governing documents and state and federal law. The default form of stock is known as "common stock," but corporations can authorize and issue other types of stock. "Preferred stock," or "preferred shares," give shareholders priority over holders of common stock regarding the corporation's earnings and assets. Preferred shareholders might be entitled to fixed dividend payments, but in exchange, preferred shareholders often give up voting rights in the corporation.
Corporate law places several important limits on classes of preferred stock. A corporation cannot elect subchapter S status, for example, if it has more than one class of shares. Courts might treat issuance of preferred shares as a form of compensation that raises questions regarding directors' fiduciary duties, as happened in New York in Lippman v. Shaffer, 15 Misc.3d 705 (N.Y. Sup. Ct., Monroe Co. 2006). The case involved a dispute between shareholders in a family-owned business over cash payments and issuance of preferred stock. The court granted summary judgment to the plaintiff on several counts and ordered the defendants to return various payments to the corporation.