(part 2 of 3)
This post is the second part in a series on the Corporate Transparency Act. Feel free to check out Part 1 here. The last post talked about how a beneficial owner under the Corporate Transparency Act (Act) can be any individual who exercises “substantial control” over the company. This post focuses on the second requirement: “any individual who, directly or indirectly, owns or controls at least 25% of the ownership interests in the company.”
Some of the readers might be thinking “Sam, that’s an easy one. Just look at the company’s shares/ownership units. If someone has at least 25% of those, then they’re a beneficial owner.” Maybe, but not so fast! There are some potential wrinkles that can make sorting out who are beneficial owners under this prong confusing.
- Profits Interests/Preferred Shares. Even though profits interests in an LLC (rights in a slice of future profits without capital investment) or preferred shares in a corporation (shares with special privileges, such as greater voting rights) can be seen as something different than their more conventional counterparts, the Act nonetheless accounts for them. If either of those interests allows an individual to hold 25% of the company’s equity or 25% of the voting power, they are a beneficial owner. For example, if Person A owns preferred shares that account for 20% of the equity in the company, but those same preferred shares account for 30% of the voting power of the company, then they are still beneficial owners, even though they have less than 25% equity.
- Options and Convertible Notes. If an individual holds options (a contract to purchase a certain number of units/shares) or a convertible note (a debt interest that may one day become equity), each of those counts toward that 25%. In other words, if Person A holds an option to purchase 30% of the company, and Person B owns 20%, but also holds a convertible note that would amount to an additional 10% of the company, both would be considered 30% owners for the purposes of the Act and should be reported as beneficial owners. Additionally, the “denominator” for determining these percentages comes for the total of all ownership interest, assuming all options are exercised, and all convertible instruments are converted into equity. In other words, the denominator under the Act assumes all options have been exercised and all convertible notes converted.
- Entities as Owners. If entities (LLCs, corporations, etc.) own the company (rather than/in addition to individuals), then the individuals that own those entities may be considered beneficial owners. Whether those “owners of owners” are beneficial owners depends on how much the entity owns of the company, and how much the individual owns of the entity. For example, assume that Company B owns 50% of Company A, Person X owns 60% of Company B, and Person Y owns 40% of Company B. Person X would indirectly own 30% of Company A (60% of 50% is 30%), which means Person X would be a beneficial owner of Company A. Meanwhile, Person Y would indirectly own 20% of Company A (40% of 50% is 20%), which would mean Person Y was not a beneficial owner of Company A.
- Community Property. See my earlier blog post to learn more about community property, but in general, if you live in Wisconsin (or a handful of other states), all property of each individual spouse is legally shared 50-50 between the spouses. The Act does not directly address this, though Wisconsin law and Department of the Treasury’s resources suggest that if one spouse is a beneficial owner, the other spouse could be a beneficial owner as well, even if the company’s records make no mention of the other spouse.
After the firehose that was this Part 2, I have the following takeaways, especially for business owner readers:
- Review Your Capital Table/Stock Ledger. Look at who owns the company, and how much of an ownership interest each owner has.
- Dig Deeper. Even if the owners are known, is there more indirect control going own (unexercised options, owners of owners, marital property, etc.).
- When in doubt, talk to your attorney. Your attorney will gladly help review you dig through your documents, digest everything, and figure out who the beneficial owners are.
Thanks for reading! Tune in next week for the final part of the series. – Sam