Electronic Equity Management Platform for Privately-held Companies: Benefits, Risks, and Costs

• Publication year: 2017

Electronic Equity Management Platform for Privately-Held Companies: Benefits, Risks, and Costs

George Akers

ELECTRONIC EQUITY MANAGEMENT PLATFORMS FOR PRIVATELY-HELD COMPANIES: BENEFITS, RISKS, AND COSTS

George Akers^*

Any lawyer or company that has worked with paper stock certificates, paper option agreements, and other paper-based securities knows how cumbersome, time-consuming, and problematic they can be.¹ The printing, mailing, cover letters, handwritten signatures, scanning, and ledger-updating can consume substantial billable legal time for what is essentially just paper pushing. Paper-based securities are also highly susceptible to typos, miscalculations, use of stale forms, or being lost or destroyed, all of which are problems that require additional paperwork and legal time to correct. In the middle of all these issues is the additional burden for the company or its counsel to manually maintain a capitalization table ("cap table") and ledger to track all these securities, usually on an Excel spreadsheet, which must be continually and manually updated with every new stock issuance, option grant, option exercise, and other security issuance. Since early-stage private companies are usually more focused on growing the company than keeping good records, these cap tables and ledgers are usually out-of-date, incomplete, or incorrect by the time the company has a financing or exit transaction, at which point the lawyers for the company must spend significant billable time to verify, update, and correct issues with the company's cap table and other equity-related documentation.

Fortunately, online software-as-a-service ("SaaS") platforms have emerged in recent years to streamline and organize the issuance and management of securities for early-stage private companies and their lawyers by making the documents involved all electronic. These equity management platforms ("EMPs")—also sometimes referred to as "cap table management

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platforms"² —vary in their offered features but generally all allow for the electronic issuance of securities and provide a more dynamic and automated cap table and ledger. Beyond the issuance of electronic securities, these platforms are also able to offer conveniences such as real-time tracking of vesting progress, modeling of financing and exit scenarios, securities laws compliance checks, inexpensive 409A valuations, and more. However, despite the various benefits to EMPs, there are also risks to using these platforms, some of which can be and are managed by the EMPs, and others that are simply unmanageable and inherent to any electronic-based system. Finally, subscription costs for EMPs range from free to very high (usually based on the size of the cap table or offered features), meaning that companies will need to consider whether their desired EMP makes economic sense for them. This article lays out in general terms the benefits, risks, and costs of EMPs so that companies and their lawyers can have a framework for making an informed decision about whether to use an EMP and, if so, the factors to consider in selecting one.

I. Benefits

There are a variety of benefits to using an EMP but they all essentially come down to time-savings and cost-savings, both for companies and their lawyers. Since law firms generally bill by the hour, the time-savings created by EMPs generally lead to reduced legal bills for clients and reduced write-offs for law firms who have fee-sensitive clients. Below are some of the most valuable time-saving/cost-saving features offered by one or more EMPs. Readers should note, however, that not all EMPs have the following features or the same features, so companies and lawyers interested in using an EMP should carefully evaluate it to ensure that it contains the features most important to them.³

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A. Issuing Electronic Stock Certificates

Replacing paper stock certificates with electronic ones is one of the biggest ways that EMPs can save time and money. Prior to EMPs, when a private company needed to issue stock certificates, the following steps would generally need to be taken:

(1) the attorney would provide the stockholder's information to a paralegal;
(2) the paralegal would type up and print off the paper certificate;
(3) the attorney would review the stock certificate for accuracy;
(4) the paralegal would draft a cover letter and mail the certificate to the company for signature by the company's officers;
(5) the company would receive the certificate and have the officers sign by hand;
(6) the company would scan and email a copy of the signed certificate to the law firm for the firm's records;
(7) the paralegal would save the copy of the signed certificate to the law firm's files and update the Excel spreadsheet stock ledger and cap table with the certificate's information; and
(8) the company would then mail or personally deliver the certificate to the stockholder.

This whole process of issuing a paper stock certificate can take several days from start to finish and can incur significant legal fees and shipping costs (if using FedEx, UPS, or another overnight carrier). The pain continues later on if the certificate needs to be canceled or if shares need to be transferred, requiring the following additional steps:

(1) the law firm would email or call the stockholder to request that he/she mail the certificate to the firm;
(2) once the certificate is received by mail, the paralegal would then stamp "canceled" on the certificate, save a scanned copy to the firm's records, and place the paper copy in the company's minute book or files;
(3) the paralegal would then create a new stock certificate for the recipient of the transferred shares (if shares are being transferred), and the rest of the certificate issuance process described above would continue from there.

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With EMPs, however, the attorney can quickly input the stockholder's information into the EMP platform, click a button to send the electronic certificate to the officers for electronic signature, the officers would receive an email from the EMP requesting their signature, they would click the link in their email and electronically sign, and then the signed certificate would be automatically emailed to the stockholder for his/her acceptance.⁴ Any cancelation⁵ or transfer of shares⁶ can likewise be done with a few clicks of a button by the attorney. The legal time-savings in this one respect can be quite meaningful, and this is just one feature of EMPs.

B. Issuing Options and Other Securities Electronically

EMPs also allow lawyers to quickly and electronically issue options, warrants, and convertible securities, significantly cutting down on legal time and costs. Before EMPs, when a company wanted to issue stock options, the following steps would generally need to be taken:

(1) the lawyer would draft Board resolutions approving the options;
(2) the Board would approve the resolutions either at a Board meeting or by written consent;
(3) the lawyer would fill in the company's form of option agreement for each of the option recipients;
(4) the lawyer would email the option agreements to the company for the company and option recipients' signatures;
(5) the company and option recipients would sign the option agreements⁷ ;
(6) the company would scan and email the signed option agreements back to the law firm;
(7) the paralegal would save the copies of the signed option agreements to the firm's files; and
(8) the paralegal would update the option ledger with the new options.

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With EMPs, the steps for issuing options are mostly handled automatically by the EMP and include:

(1) the lawyer inputs the information for the new options into the EMP as a draft and attaches the pre-saved form of option agreement and stock incentive plan to the option grant by clicking a button;⁸
(2) the lawyer marks the drafts of option agreements as requiring board approval;⁹
(3) the EMP automatically populates a board resolution to approve the new options and, once approved by the user, the EMP sends it to the board members' email addresses for electronic signature;¹⁰
(4) the board members sign the board consent

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