Key lessons in Australian crowd-sourced funding.
From set up to shareholders- understand your legal obligations to ensure success.
Part 2 of 5: managing the logistics of increased shareholders
In this, the second of a series of five articles, McCullough Robertson’s start-up expert, Partner Ben Wood discusses some of the options available to a crowd-sourced funding (CSF) company to handle its members register and corporate documents more efficiently.
Electronic members register
With CSF inevitably comes the ‘crowd’. Using CSF can cause a large increase in the number of shareholders in a company if the funding is successful. Companies should be mindful of whether their current corporate structure and agreements can handle this influx of shareholders. Or, if their structure even allows them to sell equity at all – for example, in the case of partnerships, sole traders and certain trusts.
Where a business is already set up as a proprietary company, or becomes one in order to take advantage of CSF, it needs to be aware that it may end up with hundreds, or potentially thousands, of new shareholders after a successful offer. These new shareholders will all need to be entered in the company’s register of members and their details must be kept up to date, as required by the Corporations Act 2001 (Cth) (Act), to enable the company to provide them with any notices and effectively communicate with them.
Fortunately, the Act allows for the members register to be maintained electronically. This means that a company can maintain, and update, its members register electronically. This is a particular benefit for companies that have a large shareholder base, as it allows for easier access and updating of the members register.
If a decision is made to store records electronically, the Act requires that:
- records are capable of being reproduced, at any time, in written form. For the purposes of electronic registers, this means: in a commercially-available spreadsheet or database application, copied onto a CD-ROM or USB;
- the company takes reasonable precautions for guarding against damage, destruction, or falsification of the records. This may include things such as: restricting access to the records to particular, appropriately-trained employees, encrypting the data (especially where using cloud storage), regularly conducting virus checks, and backing up the register and maintaining that back-up;
- records cannot be more than 20 days out of date. As a matter of good practice, a company should be updating its members register as part of the completion of a new share issuance or transfer of shares; and
- the information is retained for seven years.
Additional comments from Cake Equity:
By using a cloud-based share register like Cake, the company can allow the members to check their own details and request any corrections or updates. Cake provides all investors with an investor portfolio account, where they can view their holdings, their investment documents, and check their details. This can be especially useful just following a CSF raise, where some investors will make accidental errors in their initial information, and the company can correct that information before it is used elsewhere.
It can also remove significant administration in having to respond to enquiries from shareholders, just to provide simple information which they have misplaced. For example, if an investor misplaced their share certificate, it would be stored automatically on their Cake profile, so they could simply be directed there.
Its best practice to set your company up on the online registry provider before conducting the CSF raise.
This will allow you to ensure your cap table is accurate and up-to-date prior to issuing any further shares. For example, you may need to conduct a share split before issuing further shares, or you may wish to implement your employee share option pool into your cap table. On Cake, you can execute these transactions with the guidance of your advisor and keep a clear transaction history so that everything occurs in the correct order.
Do you need a shareholders’ agreement?
There are two main documents that outline how a company operates from a governance perspective: a shareholders’ agreement (a contract entered into by all shareholders) and a constitution (which shareholders are bound by when they acquire or receive shares in the company).
In the early stages of a company, where there is a limited number of shareholders, a shareholders’ agreement can be quite simplistic, covering off on the day-to-day operations of a company and its decision making processes. To accommodate a CSF offer and the introduction of new CSF shareholders, any shareholders’ agreement that is in place will need to be reviewed and almost certainly need to be substantially amended.
Ordinarily, a constitution sets out the fundamental rights and obligations as between the shareholders and the company, as they apply to them. A shareholders’ agreement provides more specific details about the shareholder relationship, or certain rights and obligations between shareholders and the company.
There can be practical difficulties having both a constitution and shareholders’ agreement operating at the same time, especially where there is a large shareholder base. For instance, to amend a shareholders’ agreement, a company ordinarily needs approval from all of the shareholders; whereas, to amend or replace a constitution, the Act only requires the approval of 75% of shareholders present and entitled to vote at a shareholder meeting. This lower threshold means that the shareholders can amend the rules of the company without necessarily seeking individual approval of all shareholders.
While there is a requirement for a company to have a constitution (or otherwise be governed by the replaceable rules in the Corporations Act), there is no such requirement for a company to have a shareholders’ agreement. As such, a CSF company could potentially proceed without a shareholders’ agreement and, ahead of making an equity CSF offer, put in place a more tailored and detailed constitution. The constitution could encompass the specific rights and obligations of shareholders that may otherwise be found in a shareholders’ agreement.
Additional comments from Cake Equity:
While it’s often best for a company to structure their constituent documents to allow maximum company agility, if a company still does need shareholder approval for a certain matter, it can make a huge difference if they provide some context to the relevant shareholders before they seek it.
On Cake, a company can provide regular updates to all its investors (or selected sub-groups) through the platform. This will ensure the investors are kept in the loop, and that they will be more willing and ready to cooperate if their approval is needed for any matter.
The company can also then streamline and automate the sending and signing of documents to hundreds of shareholders at once through the platform.
In working with his clients, Ben has developed constitutions that fit the size and stage of the company’s business, capital round, shareholder profile and number of shareholders.
In the next article, Ben covers some constitutional rules and strategies that will assist to better define the rights and obligations of shareholders in a CSF company.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.