Congratulations – you have just completed a successful equity crowdfunding round as you have welcomed 500 new shareholders to your company – now what?
There are many practical consequences for a small company in suddenly finding itself with a greatly enhanced shareholder base. The purpose of this note is to flag up the important issues and suggests ways in which they might be dealt with.
Rules of Engagement
Some of the crowdfunding platforms use a nominee arrangement which leaves their nominee responsible for communicating with the underlying beneficial owners of the shares. Others expect the investors to become direct shareholders in the company, some expect all shareholders to have the same rights, some have large investors with voting rights and smaller investors who do not and some look for a degree of investor protection whereas others simply rely on the provisions of the Companies Act. You should therefore be very clear about the Rules of Engagement before entering into your crowdfunding project so that you know exactly how to play by the rules once your project has been funded.
Register of Members
It is a basic requirement of the Companies Act that a company should have a Register of Members. This comprises three parts, namely:-
- The Register of Allotments which details the issue of all new shares, the price subscribed for each share and the name of the party to whom they are issued;
- The Register of Transfers which contains details of all share transfers; and
- The Register of Members itself which contains a complete up to date record of all current shareholders, including their names and addresses and their shareholdings of each class of shares. These records are fundamentally important as they determine who owns the company and in what proportions and they will be relied upon when the Company is sold to determine who gets the sales proceeds and in what proportions. If these records do not exist or are inaccurate, incomplete or not up to date, it will be difficult/impossible to sell the Company.
Creating a Register of Members for a large number of shareholders is not an insignificant task. The process can be streamlined to a certain degree by using one of the company secretarial software systems on the market (such as Blueprint) but these are expensive and are really aimed at lawyers or company administrators who look after 100’s of companies, or larger group companies who have several subsidiaries.
At this moment in time, the suppliers of these software programmes have not caught up with crowdfunding, so there is no slick way of importing data straight from an Excel spreadsheet. This means that your lawyer will have to manually input (or handwrite) every single entry, which can be a costly exercise. It is early days, but at the date this briefing note was published, some crowdfunders had given little or no thought to this process. Furthermore, time after time they fail to inform the company of its legal obligation to maintain a Register of Members or advise them of the potential cost of entering the data and maintaining it. The company’s lawyers then end up looking like the bad guys when quoting fees running to hundreds of pounds to make the company compliant.
A company must file an Annual Return detailing the names of its Members and their shareholdings. Provided the Share Register is set up on a Company Secretarial programme which is regularly maintained and updated, the filing of an Annual Return is a relatively straightforward task. Without such a programme however it could become a labour intensive nightmare and the Companies Office often imposes fines on companies which file their Annual Returns late or fail to file them at all.
The Company is only responsible for maintaining a record of its registered Members. That means that it only needs to maintain a record of the nominee shareholder who is then responsible for dealing with the underlying beneficial owners. It would however be prudent to check the status of the nominee shareholder as significant issues could arise if it disappeared and along with it the records of the underlying beneficial owners.
Many crowdfunded companies will qualify for EIS relief. The responsibility for obtaining and distributing the relevant EIS Certificates to shareholders will normally rest with the Company itself.
Annual General Meeting
The default position is that a private company no longer needs to hold an AGM unless its Articles of Association specifically require it to do so. As it would be impractical for a small private company to hold an AGM for hundreds of shareholders it is essential that the Articles of Association should be checked to ensure that the default position (i.e. no requirement to hold an AGM) is adhered to.
The Companies Act permits a company to communicate with its shareholders electronically. It is therefore essential that the Register of Members should include up to date e-mail addresses for all shareholders as the cost and inconvenience of a physical mailing to a large shareholder group is substantial.
Change of Circumstances
With a large shareholder group, it is inevitable that there will be changes of address (including e-mail addresses), deaths and incapacities through shareholders becoming unable to look after their own affairs or otherwise incapacitated through insolvency. The Articles of Association will need to provide for the shares of deceased and incapacitated shareholders to be transferred to their successors in title and all “shareholder events” will need to be entered into the Register of Members so that it is kept constantly up to date.
Small private companies generally have fairly restrictive share transfer provisions including “offer round” provisions. The basis of an offer round provision is that, if any shareholder wishes to sell, they must in the first instance offer their shares round all other shareholders in proportion to their respective shareholdings before they can be offered for sale to a third party. It would clearly be completely impractical for a small shareholder to offer his or her shareholding round a large shareholder group and careful thought will therefore need to be given to appropriate share transfer provisions and this may include :-
- Unrestricted share transfer provisions up to a certain limit, possibly 24.9%. Any shareholder with 25% or more of the issued share capital would have blocking rights and the Company may wish to avoid giving any one shareholder or group of shareholders so much influence over the affairs of the Company. Such provisions would need to be carefully drafted to ensure that they cover not just the individual but all persons who are connected to that individual;
- Some form of internal market for the Company’s shares so that shareholders are able to buy and sell shares from each other up to an agreed limit. Consideration would need to be given to the pricing of any such transactions – should they share price be fixed by the Company or its auditors, should there be some form of auction process or should it be left to individual shareholders to determine the price in individual transactions?
- Offering a matched bargain service or an external platform such as Asset Match.
One of the attractions of having a large shareholder base is that it enables the Company to reach out to a much wider shareholder group for future Rights Issues and this may be helpful for a company which needs to raise additional rounds of finance. However, it is essential that the shareholder group is kept informed of the company’s progress.
Regular shareholder updates are very important and it will be much easier to complete a successful Rights Issue if the shareholders are aware of the Company’s progress and the Company is able to give the shareholders a degree of confidence that it is moving in the right direction, that the directors know what they are doing and that the Company is gaining traction in the market which it serves.
Once the Company is profitable and cash generative it may want to start thinking about making dividend payments to shareholders. Consideration will then need to be given to the basis upon which such dividend payments are made, either by cheque to a physical address or by transfer to a designated bank account. It should be much easier to make payments by bank transfer but, if that is the preferred method of payment, it will of course be necessary to obtain bank account details for all shareholders.
Sale of the Company
We now move into largely unchartered territory. Private companies are usually sold by way of a Share Purchase Agreement. Such agreements are normally complex lengthy documents which contain provisions for a price adjustment based on the preparation of Completion Accounts, retentions from the price, Deferred Payments and “earn-outs” which are variable payments dependent on the financial performance of the company after it has been sold.
Such agreements generally also contain lengthy warranties which are granted by the sellers to the purchaser confirming the position of the Company as at Completion. It is difficult to envisage how it would be possible to allocate the warranty liability across a wide shareholder group although it is sometimes possible to obtain insurance to cover the warranty liability and that may prove to be the only practical solution in the case of a crowdfunded company. However, even if the warranty liability can be dealt with in this way, significant challenges will arise in accounting to individual shareholders not only for the initial instalment of the price but also for any deferred consideration or earn-out payments.
It is also possible for a private company to be acquired by way of a “General Offer” based on detailed provisions set out in the Financial Promotion Order 2005. It may be that a General Offer accompanied by warranty insurance will prove to be the most effective way of acquiring a crowdfunded company with a large shareholder base.
Whether the transaction proceeds by way of a Share Purchase Agreement or a General Offer, it is fundamentally important that the Articles of Association contain well drafted and completely sound drag-along and tag-along provisions to ensure that if some agreed majority of the shareholders wish to sell the Company, they can force all shareholders to sell on the same terms and that the minority shareholders can ensure that they have the right to sell on the same terms.
The crowdfunding phenomenon is growing exponentially and, as it grows, we must all remember that it is much easier for investors to put money into a company than it is to get it out. Much detailed thought now needs to be given to facilitating exits and ensuring that shareholders are able to earn a return on their investments.