It used to be that if you wanted to start a corporation and the end goal was not to maximize shareholder value (or other typical corporate goals), you’d start a not-for-profit corporation. That’s no longer the case. Now in New York (and at least six other states) you can form a Benefit Corporation (a “B-corp”) which has other purposes besides making money. There are also other strategies you can use in a for-profit company to give it more of an egalitarian feel. We’ll discuss below. Read more
Tag: stock
Stock Appreciation Rights
Another way to compensate employees of a corporation is to issue them Stock Appreciation Rights (“SARs” – not “sars – severe acute respiratory syndrome”, that’s something else). SARs grant employees, usually higher level executives, the right to receive stock and/or cash at a future date in an amount pegged to the increase in value of the corporation’s shares of stock over a certain time period. If the company’s share value increases, so to does the value of the SARs. SARs often are offered along with traditional stock options, although they are granted seperately (if done with stock options, sometimes you will see them called “Tandem SARs”). Read more
Corporate Dual Class Share Structures
A dual class share structure is used in certain corporations where one or more classes are given all or a bulk of the voting rights and another class or class has the same economic interest in the company, but none of the voting rights. There can also be other rights that are given to one class instead of the other. This type of structure is used so that the existing Board of Directors and management of the corporation maintain their control of the company. It bcaeme common in news organizations (think the Economist Group, or the News Corporation a la Rupert Murdoch) so that the company could ostensibly keep its journalistic integrity and credibility or to stay true to its goals, without pesky shareholders muddying the waters.
A dual class share structure can serve desirable goals, such as shielding management and the board from short term views of dissident shareholders/analysts and hostile takeovers. This can be helpful, as the constant quarterly pressure to meet revenue expectations is a burden on many companies at the expense of long term sustainable growth. Management at companies with dual class structures argue that if shareholders aren’t happy with the structure, they are free to sell their shares and walk away. Not surprisingly, only companies that are rather a hot commodity in the market can really get away with using this structure.
SEC proposed regulations would allow general solicitation and advertising in a Rule 506 financing
Last week the SEC issued its proposed regulations to allow for public advertising and general solicitation in Rule 506 offerings.
As way of background, at this point when companies are trying to raise funds in a private offering, they typically rely on Rule 506 of Regulation D of the Securities Act of 1933, which allows for an unlimited amount of funds to be raised and minimal disclosure requirements if the securities are sold to accredited investors. Offering undertaken pursuant to Rule 506 also preempt state securities laws, except those relating to fraud and notice filing (and notice filing fee) requirements. While all of the above makes Rule 506 the “go to” securities law exemption, the main reason it was originally allowed is because it has historically only been able to be used in private offerings, where the issuer (or the broker acting for the issuer) had a pre-existing relationship with the investor.
The JOBS Act, which I’ve discussed, contained a provision which would require the SEC to promulgate regulations to allow general solicitation and advertising in Rule 506 offerings, provided that all purchasers in such offering are accredited investors.
Using “Convertible Equity” instead of Convertible Debt
As I’ve discussed, an option for startups to raise money is to do a convertible debt financing. In this sort of a transaction, the investor gives the company a loan evidenced by a convertible promissory note. The note is convertible upon a later financing round into the same type of securities that the financing round’s investors receive, and the note holder gets a discount on the per share purchase price. The benefits of this are that it is generally much quicker and straightforward than a typical seed/angel round and the company and investor do not have to have the awkward and difficult conversation regarding valuation of the company. The detriment to this type of transaction is that the company’s balance sheet is saddled with debt, and if the company does not raise another round of investment before the term of the convertible promissory note comes due, then the investor can essentially bankrupt the company if the investor does not want to extend the due date. Also, there are a good amount of investors that do not like investing through a convertible note, as one of the important terms – how much of the company the investor will own – is up in the air.
Recently, TheFunded.com and the Founder Institute annouced the introduction of a new concept called “Convertible Equity”. The concept and draft documents, were put together by Yokum Taku or Wilson Sonsini and a top accounting firm. TechCrunch has a good write up on it.
The form documents are available for free download here.
From a quick review of the documents it seems to be a great compromise. There would be no more maturity date or interest due. The startup will not have any debt on its books, and the investors would have the opportunity to qualify for the exclusion available on gains for holding “qualified small business stock”. It will still leave open how much of the company the investor actually owns, however, but that can probably be resolved using a valuation cap or some similar mechanism that can be drafted into the convertible equity documents.
The documents appear to automatically convert into shares of the company stock upon a change in control or qualified investment. There doesn’t appear to be an option for the investors to decide to convert at will or in any other circumstance, although certain provisions can be added for different situations.
This would be great if it gets adopted in the startup community, but like anything, it may take awhile. I know I will be recommending it as an alternative to convertible debt.
Crowdfunding – Prepare your Company to Crowdfund
As I’ve discussed earlier, the SEC is now preparing regulations to allow for Crowdfunding pursuant to the recently passed JOBS Act. These should be done by 2013 (emphasis on should be done by then – we’ll see when they actually come out). As you may have heard, it will allow for true equity sales over the World Wide Web. Companies will soon be able to sell shares of their corporation (or LLC) through online portals to regular persons that are not accredited investors (i.e. not millionaires or otherwise sophisticated).
There are a couple of things to discuss, the first is whether this is something your company actually would want to do. The second item is, if it is something you want to do, then what can you do to prepare your company to do a Crowdfunding raise in 2013 (or whenever the SEC finishes the regulations).
Pricing Stock Options – IRS Code 409A Treatment @ Paper this Deal
We’ve covered the bare basics of stock options on this blog before. Here we will look into something that is all important when issuing stock options – that is the option’s exercise price. The exercise price is the amount an option holder needs to pay in order to exercise the option to receive the share of underlying stock. Most option holders will not exercise their options until the price of the underlying stock has risen higher than the exercise price, so that they can receive the shares and then sell on the open market for a profit. The IRS got keen on the fact that a company could issue stock options with an artificially low exercise price, which would allow the option holder to immediately exercise the option to receive the shares with the greater value and sell those shares, which is in effect as if the company paid cash to the option recipient. Hence Section 409A voted into effect in the American Jobs Creation Act of 2004. The reason stock options can receive beneficial tax treatment is because they are treated as deferred compensation. To get that treatment, stock options should only be granted with exercise prices at or above the fair market value (“FMV”) of the underlying shares of stock on the date of the option grant.
Convertible Debt Financing 101
One way that a startup can take seed or angel investments is by doing a convertible debt financing, sometimes called a bridge loan or bridge financing. It is essentially a loan the company receives which allows the investor to later convert the amount due into a certain number of preferred shares upon the company’s next round of equity financing.
Remember to make your 83 B elections! Here’s why and how to do it
As I’ve written about in the past, founders of a startup should have their equity vested. There are times when you may not want to, but the majority of the time it is beneficial. Some investors may insist upon it, although its one of the things in the negotiations. If the founder’s stock is vested, they should make an 83-b election. To not do so could turn into a lot of tax due to the IRS over the years the stock will vest. We’ll discuss how it works and how to make the election here. Read more
JOBS Act Breakdown – What the New Crowdfunding Law Actually Means for Startups
This is a follow up to my last post regarding the concept of crowdfunding in general and the progress of the JOBS Act through Congress (full name – Jumpstart Our Business Startups Act). Since then, the Senate revised and passed the JOBS Act in a 73 to 26 vote. The House then, voting on the amendments made by the Senate, passed it by a vote of 380 to 41. This is something that both parties agree on, and were eager to work together to implement. Josh Earnest, the White House Deputy Press Secretary, stated that President Obama will sign the JOBS Act into law this Thursday, with a bipartisan public announcement. The President and Eric Cantor, one of the champions of the JOBS Act, will appear together for the signing of the bill into law.
This post will detail the provisions of the JOBS Act and how they will affect companies going forward. The JOBS Act can be found here if you’d like to take a read. After it is signed into law, the SEC has 270 days to promulgate regulations. Expect the SEC to claim that they need more time, as the JOBS Act is a monumental change, and there are various consumer (i.e. the new investor) protections required, especially to prevent fraud which, unfortunately, could run rampant if left unchecked. Hopefully Congress can put enough pressure on the SEC to get the regulations complete in the actual 270 day time period, and the regulations will actually have some teeth with respect to fraud without stifling startup’s ability to raise money.