I'm in the process of starting a business in Colorado and I will need investors to get things started. I already have several people who want in, but this is my baby and I want to retain full control over the company decisions. Primarily in the scenario of an offer the be purchased by another larger company. Is it possible to have silent investors who are just along for the ride?
Yes, it is possible to have investors that don't have voting rights (along for the ride). To do that legally and effectively, however, is complicated.
Let's start with your idea of using an S Corporation. You can structure that certain stock can vote and other stock cannot. However, an S Corporation cannot issue multiple classes of shares. If you try to do that, you will lose the S Corporation status. The problem here is that often investors will require specified rights (called preferred) and if that is the case you cannot use an S Corporation. You could also structure this as a regular C corp or it could be structured as an LLC and there you can issue any number of different classes of interests.
Regardless of the structure that your business attorney advises, the most important and complicated issue is compliance with state and federal securities laws. Your offer to investors must comply with these laws. If you don't, the investors can demand every penny back plus interest and you face both civil lawsuits and actions by state and federal regulators. Depending on the issues, you also face criminal prosecution.
You say you have several people who want in. That would be a concern because what you said and who you talked to about this could have violated securities laws. Your business attorney would want to know right away what you have said and who you have talked to about this.
So start contacting local business attorneys that understand securities offers so they can discuss the issues and the strategies.
This answer is for informational purposes only and is not legal advice regarding your question and does not establish an attorney-client relationship.
As Mr. Murillo states, in addition to the structuring aspect of your business, you face a significant issue with respect to the offer and sale of securities. That will require registration or compliance with an applicable exemption that will dictate the manner of offering, level of disclosure, and suitable investors and will require filings with the SEC and applicable State Securities Administrators.
As regards the structure of your business, you can maintain control of the entity but the specifics will determine whether an S Corp. would be available to you or whether another entity might be preferable.
You should consult with an experienced Securities or Business Attorney to assist you with these important issues.
The foregoing discussion does not establish an attorney-client relationship, is qualified by the limited facts presented above, and should not be relied upon as legal advice. To obtain definitive legal advice upon which one can rely necessitates retaining an attorney who is qualified in this particular area of the law.
Congratulations on getting your business off the ground. Some solid advice has been given to you already. But here is a little more. When it comes to financing a business, you can finance it with equity, or you can finance it with debt. When you finance your business with equity, you are giving up an interest in the business by selling people shares in the business. Those individuals then become owners in your business, whether they have voting rights or not. Limited voting rights will help with management of the business, but in the end, they are still owners, and you still have obligations to them as such. Equity financing, on the other hand, basically means the business is going to borrow money and promise to pay it back, plus interest. The lender, then, is owed money but he/she has no right to vote or manage any aspect of the business. Think of this like borrowing money from a bank. The downside, here, is if the business goes belly up, you are still obligated to pay on the loan. With equity financing, as mentioned above, there is no obligation to pay it back, unless such terms are written in an agreement. So, your "investors" might be SOL. But be careful. I have seen many situations where investors get pretty pissed off when you lose their money despite warning them of the "dangers of investing in startup businesses." You will have significant disclosure requirements and any misleading of information, no matter how slight, could expose you to criminal or civil prosecution.
The reason for this is because, in both equity and debt financing, you are taking control of someone's and that person is losing control of their money. By definition, that is the sale of a security. And with the sale of a security comes significant regulatory and statutory control. But your exposure is very fact specific, and it entails a legal analysis of every action you've done from when and how you met your first investor to the first dollar that was invested. Do not try and navigate this aspect of your business alone. There is too much risk. Get a lawyer involved.
This isn't meant to scare you from reaching for your dreams by any means. It's meant to educate you so you don't trip out of the starting gate. Spend the money, and the time on good legal advice. It will be the best investment you make.
The Contiguglia Law Firm, P.C. / Providing unique solutions to move your business needs forward! We do law differently. / www.contiguglia.com / Just because I answered your question, that does not create an attorney - client relationship between us unless and until there is a written fee agreement in place formalizing our attorney - client relationship.
You may do what you want, but you may need shareholder agreements, proxies, voting agreements, and/or anything that could allow you to retain control. Some may argue you could consider a nominee shareholder structure. The key is that you cannot openly structure the S Corp with different classes of investors, but you can still maintain control of the company.
You might also consider a limited partnership. You would be the general partner who runs the day-to-day activities and bears unlimited liability for the debts and obligations of the partnership, and one or more limited ("silent") partners who provide venture capital, have no voting rights, and whose liability is limited to the amount of their investment. In return for their investment, limited partners share in a percentage of the profits. Colorado law would govern such arrangements by statute. The terms and conditions of such an arrangement are spelled out in a Limited Partnership Agreement, structured in accordance with applicable Colorado law. As my colleague noted, these arrangements can be complicated and require an attorney with experience and expertise in these areas.
Yes, absolutely. I many times draft bylaws making the founder the Director giving him/her day to day management functions. There are also additional methods to structure the deal to avoid shareholder control of management. I agree with the other posters that securities laws are important to consider, and that investors have to agree to your terms. However, it appears you are in a seed round, and these issues are usually not very daunting/the investors not very demanding at that stage. The devil is in the details though.
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