Most startups will be categorized as “reporting companies” under the Corporate Transparency Act (the “CTA”) and will be subject to the CTA’S Beneficial Ownership Information Report (“BOI Report”) obligations at the end of this year. As we wrote about in our recent blog post on the CTA, it may take some diligence to determine who qualifies as a beneficial owner for your company’s BOI Report—especially if your company is a startup.
Beneficial owners are individuals who: (i) exercise substantial control over a reporting company, and/or (ii) directly or indirectly own 25% of the ownership interests in a reporting company. While this may seem straightforward, certain common aspects of an investor-backed startup will complicate this analysis, and your cap table may not tell you everything you need to know. Below are just some of the additional ownership factors that we are analyzing with our startup clients as we prepare their BOI Reports.
Stock Options and Convertible Instruments
Stock Options, like those that you might issue through your company’s employee equity incentive plan, are not usually considered part of your company’s “issued and outstanding capitalization.” Similarly, rights that result in a future promise for equity, such as those conferred by a convertible note, SAFE, or warrant, are not typically considered part of a company’s capitalization until they have been exercised or converted. For the CTA, however, the future rights conferred by stock options and convertibles must be treated as exercised and converted and must be included in the total number of ownership interests that are used to determine each beneficial owner’s ownership percentage.
Corporate Stakeholders
No corporation, LLC, or other corporate entity can be a beneficial owner under the CTA. So, what happens when a fund holds 40% of your cap table? Unfortunately, corporate ownership doesn’t end the beneficial ownership inquiry, it starts it. When a corporate stakeholder is on your cap table, the corporate stakeholder’s equity percentage must be subdivided and allocated to each of that corporate stakeholder’s individual owners. If any of those individuals hold enough equity in the corporate stakeholder, such that their indirect holding in the reporting company is greater than or equal to 25%, that individual is a beneficial owner of the reporting company and must be named on the reporting company’s BOI Report.
Class-Specific Voting Rights
If the voting rights attached to your company’s stock or other equity units are not uniform across all equity holders (for example, because equity granted under the employee equity plan does not have any voting rights, or because certain preferred stockholders have two votes for every share of stock that they hold), these differences in voting powers must be factored into the total number of ownership interests that are used to determine each beneficial owner’s ownership percentage.
Getting an early start in preparing your BOI Report and consulting with us or your current company counsel will be imperative to ensuring that your BOI report is timely and correctly filed by the December 31, 2024 deadline.
