AdobeStock_360784031-300x200Registration of securities is a legal requirement that costs investment funds time and money. It is important to stay compliant with all applicable securities laws, so if registration is not financially or logistically feasible, be sure that you have a recognized exemption from the registration requirement. These exempt offerings are designated as “EB-5” under United States securities laws. EB-5 is also a designation used for the visa a foreign investor must obtain in order to invest in an EB-5 fund. EB-5 investments are also called private placements or unregistered offerings. Learn more about some of the common legal issues that arise with EB-5 offerings, as well as how investors and offering companies can protect themselves from financial and legal liabilities in relation to them.

Relying On Exemptions From Registration From Securities Laws

SEC Rules 504, 505, and 506 establish exemptions from the registration requirement for certain securities. These rules specify how much equity may be sold by an offering entity in a twelve-month period, how much money may be raised, and whether the investors must be accredited in order to maintain the offering’s eligibility for exemption from the registration requirement. These rules also specify the manner of advertising that may be used for the offering. Each of these rules provides specific legal guidelines that must be met exactly. Failure to meet the exemption requirements can subject a business to fines, penalties, legal liability, and administrative requirements (such as limits of offering securities in the future).

AdobeStock_309353202-300x199An equal split of shares between founders often seems like the fairest way to split equity in a young business. While this may be the simplest option, it comes with many hidden risks that most entrepreneurs are not aware of until it is too late and the business is in serious trouble. New companies can avoid this problem by working with an experienced startup lawyer from the very start. At Structure Law Group, we help entrepreneurs build a successful business from the ground up. Whether it is making decisions on your business entity type (i.e. choice of entity), your management structure, or your equity compensation, we advise and help design a company that is best suited to your unique needs.

Why Equal Split Of Shares Is the Worst Structure

There are many reasons why an equal split of equity can be the worst structure for the founders of a new business. Often, founders have different ideas about the contributions they will be making to the business. Some envision the creation of intellectual property, while others want to manage marketing and business plans. Some want an active role in the daily management of the company, while others want to invest more passively. These issues cannot be resolved in a single meeting. Often, founders must work together for a time in order to learn each person’s working style, expectations for each founder’s contributions, and vision for the company’s future. It takes partners time to know each other in a business relationship. And just as in a romantic relationship, legal agreements cannot always prevent painful and expensive litigation when the business relationship goes sour.

AdobeStock_431953977-300x169A stock option pool has become an increasingly popular tool for startup companies. Entrepreneurs seeking to attract talented employees will often offer incentives that give employees motivation to make the company as profitable as possible, and equity compensation is a very popular option. There are different ways to offer these equity options to employees, and stock options pools are a popular choice. A pool allows a company to set aside a given portion of company stock to be issued to employees as stock options. While this is a convenient structure for many businesses, it is not always the best option. Learn more about the pitfalls of using a stock option pool – and the other options that might be better for your business.

The Difference Between Stock Options and Restricted Stock

Both stock options and restricted stock are forms of equity compensation made to employees. There are different restrictions that come with each form of compensation, and it is important for companies to understand these effects before making the choice of how to offer equity compensation. Restricted stock creates a role more similar to a traditional stockholder, and the employee may vote and receive dividends. Employers may also reserve the right to buy back restricted stock (or at least have the right of first refusal) in order to maintain control of the company. Stock options are more limited. Employees are usually limited to the right to buy company stock at a set price in the future. This right can create a windfall if company stock exceeds the set price, but it does not give the employee voting or dividend rights. Because there are no voting rights and no set number of shares, employers generally do not retain the right to buy back stock options. Both restricted stock and stock options can be subject to vesting requirements in order to encourage long-term employment.

AdobeStock_67958307-300x187Delaware has long been known as a popular state for incorporation of a new business. Some entrepreneurs think this is solely because of tax benefits, but there are many legal and practical benefits to incorporating a new business in Delaware. Here are some of the most common:

Management Friendly

The Delaware General Corporation Law is considered to be friendly toward the management of corporations. There are many specific provisions that help corporations run more efficiently: for example, Delaware corporations have the option of using cumulative voting, while other states make it compulsory for corporations that are not publicly traded. The DGCL also allows for shareholder approval of mergers without separate votes in each class of outstanding stock. Special meetings can be limited to a call by the Board of Directors, which prevents the complications associated with shareholders calling special meetings. Finally, the DGCL embraces new technologies and now allows corporations to use distributed ledgers or blockchains to create and maintain the corporate records required by law. These and other provisions help corporations run more efficiently under Delaware state law.

AdobeStock_133739956-300x200New technologies have drastically changed the ways in which new startups raise capital. Securities laws and regulations are adapting to these changes to ensure that investors are still protected under federal securities laws when investing via new technologies. Regulation CF (aka Title III of JOBS Act) is a relatively recent rule that took effect in 2016 and recently updated in 2020. It allows new business startups to raise equity through crowdfunding, which means private from all Americans, instead of the richest 2% Americans. More importantly, crowdfunding is typically used for new companies to turn their customers into their investors, which is exciting news for startup founders. Learn more about how crowdfunding works, what its legal limitations are, and how to determine whether Regulation CF is the right tool for your new company’s capital funding, is added to every startup founder’s to-do list.

New Rules Raising Investment Limits

According to the SEC, companies currently may raise an aggregate of $5 million in a twelve-month period through crowdfunding securities. This is a significant increase from the original $1.07 million limit. The new limit greatly expands a new company’s ability to raise capital through crowdfunding. These changes also work to level the inequalities faced by small companies looking for startup funding options. Traditionally, large companies have had a competitive advantage in access to startup funding, but crowdfunding has changed the dynamic considerably.

AdobeStock_419006596-300x200Equity compensation is an important tool employers use to attract – and retain – talented employees. Before you begin offering stock options, it is important to consider the amount of stock being issued to employees and how issuing it could affect the value of your business. There are many ways to structure an equity compensation package. Consult with a California startup lawyer to structure compensation packages that are best for your business, your future funding rounds, your shareholders, and your employees.

Before issuing any equity compensation, it is important to understand how this will affect the value of your business. Many businesses consider stock options as an inexpensive part of a compensation package. There is no accounting cost and no cash outlay required, so stock options might seem like an attractive option. There is even an added tax benefit: the difference between the stock price and the exercise price is a tax deduction to the business. But the National Bureau of Economic Research reports that this perception does not form an accurate picture of the actual economic cost of stock options. Understand the long-term costs of stock options – and how they will affect the valuation of your business over its lifetime – before making any decisions about how many employees will be awarded what amount of stock options.

The Total Percentage of Your Employee Stock Options

AdobeStock_73458159-300x157Venture capital is a critical source of capital for any new startup. However, venture capital does not need to come with overly draconian conditions. Venture capital may be contingent on the funders receiving Board seats, and funding is typically offered in exchange for equity. But just how much equity should venture capital investors receive? If too much is given away, founders may lose control of their own business. Founders must understand how to use equity strategically in order to get the maximum benefits.

Typical Apportionments or Dilution At Each Round Of Funding

Funding must account for the competing interest of founders, the initial seed investors, venture capital investors, and employees who receive equity compensation. This can make it difficult – if not impossible – to come up with a split that everyone considers to be “fair.” While each company has different needs, here is a common scenario at a Series A round of funding with venture capital:

AdobeStock_414456803-300x118Both employees and employers need to understand how stock options work. Employers who issue stock options without understanding them can lose significant value or control of their businesses. Employees who do not understand their stock options could miss out on a significant part of the compensation they are owed for their employment. The experienced California stock option lawyers at Structure Law Group help employers and employees understand their legal rights and obligations regarding stock options.

A Timeline Of the Stock Option Life Cycle

Like other financial assets, stock options have a life cycle. Understanding this life cycle can help you understand the true value of the asset. There are three general phases in the life cycle of stock options:

AdobeStock_239826817-300x200The Board of Directors is a critical factor in the success – or failure – of any new startup company. Entrepreneurs must therefore be strategic about if and when they give Board seats to investors. Entrepreneurs must also be cautious of the total number of seats that are given away. Board seats represent voting power, and if investors create a voting block, they could change the entire direction of the company. They could even vote the founders out entirely.

The Difference Between the Board Of Directors and an Advisory Board

The key difference between a board of directors and an advisory board is the authority to make binding decisions on behalf of the company. An advisory board provides strategic – but non-binding – advice about the management of a company. The Board of Directors has the authority to make binding decisions of a company. Some investors may be satisfied to receive a seat on an advisory board and simply consult about the direction of the company. Others may require a seat on the Board in order to retain the authority to make binding decisions. This is especially common in when financing from venture capitals. Because venture capitals usually involve a larger investment than angel or seed money, finance professionals want to protect their investment by staying directly resolved in the management of the startups.

AdobeStock_299947443-300x162It is important to structure a business entity that will best meet your needs before starting a new business. Even once you have selected a corporation over a partnership or LLC, there are still choices to be made. S corporations and C corporations have some similarities. There are also critical differences, and it is important to understand how each type of corporation functions before selecting the one that will best meet your business needs. 

Only One Class Of Stock

There are several key differences in how ownership may be held in S corporations and C corporations. S corporations may issue only one class of stock, while C corporations can have multiple classes. S corps are limited to a maximum of one hundred shareholders – all of whom must be United States citizens or lawful residents. C corporations have no such restrictions on ownership. S corporations also cannot be owned by other S corporations, C corporations, LLCs, partnerships, or trusts. These stock and ownership restrictions make an S corporation unsuitable for many corporations. Be sure to consult with your business lawyer about your specific plans for issuing stock and apportioning ownership in your new business.