This blog discussed some subtle and often overlooked considerations when structuring crowdfunding offerings.
• Uncertificated Shares. Ensure that your Bylaws permit the issuance of uncertificated shares and that your subscription agreement provides that shares will be recorded in the book-entry form. Who wants to create, deliver and track hundreds of share certificates?
• Rights of First Refusal. Bylaws often include a right of first refusal, requiring all stockholders to offer the right to the company and the other stockholders prior to selling their shares to a third party. Such an obligation is extremely burdensome and impractical for companies that have numerous stockholders. Therefore, prior to engaging in a Crowdfunding Offering, bylaws should be amended to remove any such provision.
• Voting Proxies v. Non-Voting Stock. Companies often create a new class of non-voting common stock to be sold in crowdfunding offerings, to avoid providing numerous small investors with voting rights. Creating and issuing a separate class of stock adds complexity to the capitalization table, and if the company has a public company transaction, the founders will hold a different class of stock than the investors which could impact the ability of the founders to sell shares on the open market. Rather than creating a new class of non-voting stock, an issuer can incorporate a voting proxy in the subscription agreement for crowdfunding offerings, pursuant to which the investors grant the company’s CEO the right to vote their shares. If an issuer insists on creating a separate class of non-voting stock, we recommend including within its Certificate of Incorporation, a unilateral right of the Board to convert the non-voting stock into voting stock.
• Ambiguous Perks. I often see companies offering open-ended or ambiguous investor perks. For example, investors of $1,000 or more get 50% off all products purchased. You may gain an unwelcomed distributor of your product, who can purchase unlimited quantities in perpetuity for 50% off and open an eBay store and undercut your price by 25%. Always place a monetary limit, a time limit or a resale prohibition on your perks.
• Electronic Notices. Ensure your Bylaws and subscription agreement permit electronic communications to your stockholders.
• Buy-Out Rights. Institutions or private equity may be reluctant to invest in a company with hundreds of stockholders. For this and other reasons, consider incorporating a right to buy out crowdfunded investors. The buyout could be based on an annual return or a third-party valuation.
The information contained in this article is strictly for educational purposes and is not intended to be legal or tax advice or to be relied upon by anyone without doing their own research, and consulting with legal and tax advisors.