How to Set Up a Silent Partner for a Corporation

By John Cromwell

The appeal of the corporation is that it is structured to promote investment. Formed by filing articles of incorporation with the state where it is headquartered, a corporation allows shareholders to participate in the business and claim a portion of business income without being personally liable for the business’s debts and liabilities. A silent partner is someone who invests in a business and has right to dividends but does not participate in business management. Corporations can issue different types of stock with different voting rights, allowing for silent partners.

Step 1

Review your articles of incorporation and bylaws. The articles of incorporation identify what types of stock the corporation can issue. The corporate bylaws are the rules agreed upon by the shareholders when the corporation was formed regarding how the business will manage its internal affairs. Some of the issues that the bylaws may govern include the procedure for voting on amendments to the articles of incorporation.

Step 2

Amend the articles of incorporation if they do not authorize preferred stock. Preferred stock gives the holder a preferential claim to the corporation’s earnings but no vote on business matters. Generally the bylaws establish how to amend the articles of incorporation. If the bylaws are silent on the issue, you must use the law of the state where the business is incorporated to determine how to amend the articles. You will normally need a simple majority vote of the current shareholders, although a greater majority or a unanimous vote may be required, depending on the state.

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Step 3

Take a vote among the common stockholders on whether to issue the preferred stock. Once you have established that you can issue the stock, you will still need a formal vote of the current shareholders to sell the preferred stock. The bylaws should provide the procedure and voting requirements to authorize the sale of preferred stock.

Step 4

Set the purchase price for the preferred stock. Determining the preferred stock’s price is difficult because you must value the business a whole. One possible method involves determining the total value of the business assets and dividing that by the planned total number of shares. Another method involves calculating the total net present value of the business’s future income and dividing that by the total planned number of shares. Finally, you could base your preferred stock price on other comparable publicly traded preferred shares.

Step 5

Draft a stock purchase agreement. The stock purchase agreement should identify your corporation as selling the stock, the purchaser and the purchase price. The agreement should also clearly state that the shares are preferred and that the purchaser would have no voting rights in the business.

Step 6

Execute the purchase agreement. Have the purchaser and a corporate representative sign the agreement. Accept the purchaser’s money and transfer the preferred shares.

Step 7

Record the issuance of the preferred stock on your corporate books. This transaction would only affect the balance sheet. Debits increase asset accounts while credits increase equity and liability accounts. Debit the asset account of “cash” by the amount of money the corporation received for the shares. Credit the equity account labeled “preferred stock” by the same amount.

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