Accepting shares in a company
July 26, 2005 2:58 AM Subscribe
We build web-based software. A friend who owns an established company is offering a portion of her company's shares in return for our involvement in leading her business' venture into e-commerce, knowing well that it has to be a long-term commitment.
What are the benefits of being a shareholder in a company? What should I look out for, and what should I expect in return? Do I draw a monthly director's fee? What are my liabilities? How do I determine the company's share values?
You need to think about the position of your company and where it's headed.
You said that your friend wants to offer stock because she wants to create a more integrated, longer-term relationship. Perhaps that's part of it, but I'm also guessing it's because she doesn't want to give you cash for one reason or another. So, if you take on this project, where is the money going to come from? Is your company in a position to be involved in a long-term project with little or no direct revenue?
You also said you build web-based software. This says to me that you have a business model beyond just one-off projects, and you prefer to explore the vertical rather than horizontal market. Being locked into a large, involved single project for one company will fundamentally change your ability to continue to do that. So you have to evaluate whether that makes sense for the company.
There are a million other things to think about. As chrismear said, there are different kinds of entitlements. Be very careful of this. If some investors have preferred stock and you get common stock, the percentage of shares you get isn't the only thing that matters. The value of your stock will be much less.
posted by frufry at 5:09 AM on July 26, 2005
You said that your friend wants to offer stock because she wants to create a more integrated, longer-term relationship. Perhaps that's part of it, but I'm also guessing it's because she doesn't want to give you cash for one reason or another. So, if you take on this project, where is the money going to come from? Is your company in a position to be involved in a long-term project with little or no direct revenue?
You also said you build web-based software. This says to me that you have a business model beyond just one-off projects, and you prefer to explore the vertical rather than horizontal market. Being locked into a large, involved single project for one company will fundamentally change your ability to continue to do that. So you have to evaluate whether that makes sense for the company.
There are a million other things to think about. As chrismear said, there are different kinds of entitlements. Be very careful of this. If some investors have preferred stock and you get common stock, the percentage of shares you get isn't the only thing that matters. The value of your stock will be much less.
posted by frufry at 5:09 AM on July 26, 2005
If her company is not a publicly-traded company, then you will most likely be a minority shareholder in a closely-held company. In plain english, that means that you own a little while somebody else (an individual or group) owns a lot. You're along for the ride. If things go well, you can just sit back and collect some dividends for a while. If things go really well, you'll have a nice chunk of stock to cash out in the IPO. But if things go badly, you're screwed.
The problem here is that closely-held companies are not required to pay dividends at all -- ever. Also, depending on how many shares you get, you may not even have enough votes to elect yourself to the Board of Directors (and draw a director's salary). Thus, you might not get any money.
If you decide to do this, you should see a lawyer that deals with small-business issues. You need to execute a shareholder's agreement between you and the majority shareholder(s). At the very least, you need some sort of buy-out agreement so you can eventually get some money for your shares if you desire to sell them. (If it's not publicly traded, then there's a small market to sell them in, which means you won't get any money for them).
I can't tell from your post, but it does not sound like "we" is an established company. If so, you need to find a lawyer of your own. Don't use your friend's attorney, no matter what your friend or the attorney says. If you have a company of your own, then your company would be the shareholder, and your company should have its own attorney that could handle this situation.
posted by MrZero at 7:16 AM on July 26, 2005
The problem here is that closely-held companies are not required to pay dividends at all -- ever. Also, depending on how many shares you get, you may not even have enough votes to elect yourself to the Board of Directors (and draw a director's salary). Thus, you might not get any money.
If you decide to do this, you should see a lawyer that deals with small-business issues. You need to execute a shareholder's agreement between you and the majority shareholder(s). At the very least, you need some sort of buy-out agreement so you can eventually get some money for your shares if you desire to sell them. (If it's not publicly traded, then there's a small market to sell them in, which means you won't get any money for them).
I can't tell from your post, but it does not sound like "we" is an established company. If so, you need to find a lawyer of your own. Don't use your friend's attorney, no matter what your friend or the attorney says. If you have a company of your own, then your company would be the shareholder, and your company should have its own attorney that could handle this situation.
posted by MrZero at 7:16 AM on July 26, 2005
Yup, lawyer all the way as MrZ says. Plus, you sound like you need some business education yourself, plus a larger network of informal business contacts.
posted by mischief at 8:08 AM on July 26, 2005
posted by mischief at 8:08 AM on July 26, 2005
MrZero writes "closely-held companies are not required to pay dividends at all -- ever"
No company is required to pay dividends.
posted by Mitheral at 1:39 PM on July 26, 2005
No company is required to pay dividends.
posted by Mitheral at 1:39 PM on July 26, 2005
What are the benefits of being a shareholder in a company?
You own part of it.
What should I look out for, and what should I expect in return?
As discussed above, if this is a privately-owned company (that is, not traded on a stock exchange), which seems likely, then you should think about the value of your shares. They probably won't pay a dividend. If the company fails (goes out of business, and owes creditors - who have priority - more than the assets of the company), the shares are worthless.
One thing to think about - how many shares would you get, how many shares are outstanding, and how many shares are authorized? It's fine and good to get (say) 100 shares, but if there are a million outstanding, then you own 1/100 of one percent of the company. So one quick way to look at the situation would be to get a balance sheet from the company, showing assets, liabilities, and shareholder's equity (net value). If it's worth $10 million, and you have 1/100 of one percent, that's $1,000. In theory.
Do I draw a monthly director's fee?
No. A shareholder and a director are two different things. And unless you get a substantial percentage of the company (see above; unlikely), you don't have any leverage to get yourself elected to the board. Moreover, most small business don't pay directors anything other than expenses plus perhaps a token amount (unless they're trying to siphon off profits from shareholders).
What are my liabilities?
None. Shareholders aren't liable for anything. (So if you buy Ford shares, and Ford goes bankrupt, all you can possibly lose is your investment.)
How do I determine the company's share values?
See above for a determination of the book value of the shares (net assets divided by shares). The shares of publically traded companies almost always are traded at above their book value. For privately-owned companies, it would take an expert to assign a "true" value (typically based on projected earnings), and this is normally done only when valuing a company for tax purposes (or when considering a sale).
In summary: if this company has phenomenal growth possibilities (think Google), then shares might well be worthwhile. But if it's likely to plod along for years, as is, then the owner is likely to extract profits by paying herself a good salary (rather than paying dividends to herself and other owners of shares), and you may never see a dime.
posted by WestCoaster at 2:02 PM on July 26, 2005
You own part of it.
What should I look out for, and what should I expect in return?
As discussed above, if this is a privately-owned company (that is, not traded on a stock exchange), which seems likely, then you should think about the value of your shares. They probably won't pay a dividend. If the company fails (goes out of business, and owes creditors - who have priority - more than the assets of the company), the shares are worthless.
One thing to think about - how many shares would you get, how many shares are outstanding, and how many shares are authorized? It's fine and good to get (say) 100 shares, but if there are a million outstanding, then you own 1/100 of one percent of the company. So one quick way to look at the situation would be to get a balance sheet from the company, showing assets, liabilities, and shareholder's equity (net value). If it's worth $10 million, and you have 1/100 of one percent, that's $1,000. In theory.
Do I draw a monthly director's fee?
No. A shareholder and a director are two different things. And unless you get a substantial percentage of the company (see above; unlikely), you don't have any leverage to get yourself elected to the board. Moreover, most small business don't pay directors anything other than expenses plus perhaps a token amount (unless they're trying to siphon off profits from shareholders).
What are my liabilities?
None. Shareholders aren't liable for anything. (So if you buy Ford shares, and Ford goes bankrupt, all you can possibly lose is your investment.)
How do I determine the company's share values?
See above for a determination of the book value of the shares (net assets divided by shares). The shares of publically traded companies almost always are traded at above their book value. For privately-owned companies, it would take an expert to assign a "true" value (typically based on projected earnings), and this is normally done only when valuing a company for tax purposes (or when considering a sale).
In summary: if this company has phenomenal growth possibilities (think Google), then shares might well be worthwhile. But if it's likely to plod along for years, as is, then the owner is likely to extract profits by paying herself a good salary (rather than paying dividends to herself and other owners of shares), and you may never see a dime.
posted by WestCoaster at 2:02 PM on July 26, 2005
Your situation is somewhat confusing to me. What sort of business is your friend's company engaged in? Will they be selling your software as part of a larger portfolio of products, or do they want to use your software as infrastructure to sell some other unrelated products? If the later is the case and you intend to sell to other outside customers, I would be sure to put the proper operating and IP agreements in place.
Also, stock exchanges can be a tricky subject. You have to have the right perspective to view valuation - they are not offering you a concrete price, but rather using one volatile currency (their shares) to buy another volatile currency (your shares). You should negotiate on the basis of pro forma ownership rather than a concrete price for your company.
The fact that the situtation involves two private companies can bring some benefits to you. Venture capitalists will often structure deals whereby ownership and returns are ultimately driven by future performance. However, these structures presume a sale/IPO of the company in the relative near-term (5yrs or less). If the combined company doesn't intend to pursue that type of exit, maybe a structure can be implemented whereby, in addition to common shares (ownership), you receive preferred shares that pay mandatory dividends.
posted by mullacc at 2:53 PM on July 26, 2005
Also, stock exchanges can be a tricky subject. You have to have the right perspective to view valuation - they are not offering you a concrete price, but rather using one volatile currency (their shares) to buy another volatile currency (your shares). You should negotiate on the basis of pro forma ownership rather than a concrete price for your company.
The fact that the situtation involves two private companies can bring some benefits to you. Venture capitalists will often structure deals whereby ownership and returns are ultimately driven by future performance. However, these structures presume a sale/IPO of the company in the relative near-term (5yrs or less). If the combined company doesn't intend to pursue that type of exit, maybe a structure can be implemented whereby, in addition to common shares (ownership), you receive preferred shares that pay mandatory dividends.
posted by mullacc at 2:53 PM on July 26, 2005
Dude, unless it's traded on a public market, or unless they're going to sell the company to someone for cash, then the stock is worthless. Besides being worthless, it very well could be (and in my opinion from here in Oregon,) a liability to own stock in a local small business. I'm not 100% knowledgable on this but, in some cases (S Corp vs. C Corp...) being a shareholder means that 1) you're taxed on your share of the income made by the company (even if you didn't see a dime; and 2) you are now partially responsible if the company is ever found at fault doing something illegal or if there is ever a law suit against it.
I'm not sure about the legality of this either because it's a little fuzzy but... Unless they are registered with the SEC, they cannot sell shares in their company. I don't know if this would be considered a sale of shares or just a gift, but it'd be worth looking into. Regardless, anyone (them) who is willing to part with shares of their company so easily, is not someone who's company I want to be a part owner of.
Personally, I woudn't go near a deal like this. If they cannnot pay in cash, barter with them, or make them give you their client mailing list or something else of value, take 50% of their ecommerce revenue for the first 24 months or something. Just don't take stock.
posted by pwb503 at 3:52 PM on July 26, 2005
I'm not sure about the legality of this either because it's a little fuzzy but... Unless they are registered with the SEC, they cannot sell shares in their company. I don't know if this would be considered a sale of shares or just a gift, but it'd be worth looking into. Regardless, anyone (them) who is willing to part with shares of their company so easily, is not someone who's company I want to be a part owner of.
Personally, I woudn't go near a deal like this. If they cannnot pay in cash, barter with them, or make them give you their client mailing list or something else of value, take 50% of their ecommerce revenue for the first 24 months or something. Just don't take stock.
posted by pwb503 at 3:52 PM on July 26, 2005
pwb: You're way off base.
1. A C-corp is taxed at the corporate and shareholder levels while an S-corp is taxed only at the shareholder level but only when distributions are made. S-Corps are restricted to 75 shareholders and all must be individuals. An LLC allows some more flexibility here with similar benefits. And the extent of liability to the shareholder has nothing to do with the company being public or not.
2. A company must be registered with the SEC to sell shares to the public at large. And when a private company solicits investment they must sell shares only to those deemed qualified investors by the SEC. But this doesn't restrict the buying and selling of private companies in privately negotiated transaction (such as we have here). And stock would be a perfectly fine, if somewhat complicate, form of consideration.
3. You're probably right to advise caution - but not because the transaction structure is legally problematic. Any time you take stock in another company as consideration you need to be very comfortable that you are receiving adequate value. And when that stock has no liquid market, you need to be even more careful - this is why venture capitalists require 30%+ annualized rate of return.
The moral of the story is that you need to hire a lawyer to do this.
posted by mullacc at 6:31 PM on July 26, 2005
1. A C-corp is taxed at the corporate and shareholder levels while an S-corp is taxed only at the shareholder level but only when distributions are made. S-Corps are restricted to 75 shareholders and all must be individuals. An LLC allows some more flexibility here with similar benefits. And the extent of liability to the shareholder has nothing to do with the company being public or not.
2. A company must be registered with the SEC to sell shares to the public at large. And when a private company solicits investment they must sell shares only to those deemed qualified investors by the SEC. But this doesn't restrict the buying and selling of private companies in privately negotiated transaction (such as we have here). And stock would be a perfectly fine, if somewhat complicate, form of consideration.
3. You're probably right to advise caution - but not because the transaction structure is legally problematic. Any time you take stock in another company as consideration you need to be very comfortable that you are receiving adequate value. And when that stock has no liquid market, you need to be even more careful - this is why venture capitalists require 30%+ annualized rate of return.
The moral of the story is that you need to hire a lawyer to do this.
posted by mullacc at 6:31 PM on July 26, 2005
mulacc: You're not correct about the taxes on s-corps. You are generally taxed based on the profit/loss of the business regardless of distributions. This could be ugly if the majority wants to roll profits into expansion of the business, but the minority shareholder isn't in a position to pay the tax on the profit. You can put a clause in the contract that distributions have to cover taxes for the individuals, but that's not automatic.
posted by cameldrv at 3:56 AM on July 28, 2005
posted by cameldrv at 3:56 AM on July 28, 2005
This thread is closed to new comments.
Being a shareholder in a company usually entitles you to two things: a share of the profits, and a vote in certain company decisions.
Each year, the company may decide to distribute some of its profits to its shareholders. The money is distributed proportionally according to how many shares you own. This is called a dividend.
Also, certain company decisions, like appointments of directors, may have to be voted upon by the shareholder. So you might have a say in these decisions.
However, it's not uncommon for companies to issue different classes of shares, that have different entitlements. Also, the company has quite a bit of flexibility in deciding how it operates. So you might find that you're not entitled to vote, or that you receive a different share of the profits (or none at all!).
So you should ask exactly what your share entitles you to, and you should also receive a share certificate that says how many shares you own, and of what class they are.
Your maximum liability as a shareholder in a limited company is limited to the face value of the share. In other words, suppose you buy a £1 share from the company and pay £1 for it. If the company goes bankrupt, then you probably won't get that £1 back, but you shouldn't have any additional liabilities.
If, however, you also become a director of the company and start doing things like giving personal guarantees against business loans, then obviously there are other liabilities involved. But from what you've said, you're just getting some shares, so this doesn't apply.
Of course, if you're not a director of the company, then you won't draw a director's fee, or anything like that.
The other benefit to owning a share in a company is that you own a commodity, and if the perceived value of the company increases, you could sell your shares to someone else for a higher price and make a profit. I don't know whether you're dealing with a large, publicly-traded company, or a small private company -- if it's the latter then selling your shares might be a bit more involved (and to be honest they might not be expecting you to do it at all).
Basically, if it's a larger, public company, then the main thing is the market value of the shares. If it's a smaller, private company, you're probably going to be more interested in how much share of the profit you get.
posted by chrismear at 3:51 AM on July 26, 2005