How to Pay Dividends on a Non-Publicly Traded Stock

Dividend distributions by nonpublic companies (also called "privately held companies") work in essentially the same way as dividends from publicly traded companies. In both cases, the dividends are a payout of profits to shareholders. However, privately held companies often have a limited number of owners, who may also work for the company. This can create some interesting ethical issues in setting the amount of dividends.

Determine the company's profits. As with publicly traded companies, a privately held company generally should not issue cash dividends if it expects profits to be very low or negative. Dividends are typically viewed as a disbursement of part of the profits of the company to those who hold equity in the company. So, no profits generally means no dividends.

Assess the company's future needs for the cash. Even for companies that earn good profits, it is sometimes in the company's and its shareholders' best interests for the profits to be retained by the company rather than distributed in dividends. For example, if the company is in the process of expanding and will need money to invest, retaining earnings may be more cost effective than seeking loans or additional investors. High-tech and new companies often limit their dividends for this reason.

Consider the decision makers' duty of loyalty to the company. Privately held companies often are owned by a small handful of individuals who also make the decision on the distribution of dividends. This can sometimes create an ethical problem and can produce results that are not in the best interests of the company. The decision makers (typically high-ranking executives of the company and/or the board of directors) are bound by a duty of care and a duty of loyalty to the company. That means that legally they must act with the best interests of the company at heart. However, when these people also stand to gain cash dividends, their personal financial situations may cloud their judgment. To avoid this problem, it may be advisable to include third party experts in the decision regarding dividend payouts.