Seedrs Blog

It isn’t nominal – Why a Nominee Structure is Vital in Equity Crowdfunding

It isn’t nominal – Why a Nominee Structure is Vital in Equity Crowdfunding

4th February 2013 by Jeff Lynn

One of the most important features of Seedrs is our nominee structure, whereby we hold and manage the shares of startups on behalf of the underlying investors after an investment is completed.

Using a nominee structure makes equity crowdfunding easier to manage.

While it may seem like a technical point, this type of structure is actually essential to any equity crowdfunding model: it is necessary not only to enable startups to raise follow-on funding but also to ensure that investors’ interests are protected.

I would like to use this blog post to explain how our nominee structure works and why it is so critical.

What is a nominee?

A nominee arrangement is a very common structure whereby the nominee holds legal title to the shares for the benefit of another person. This means that Seedrs is the legal shareholder in the relevant company’s shareholder register, but we hold those shares on behalf of the various individuals who had invested in the company through Seedrs. The effect of this structure is that while Seedrs holds the shares, the full economic interest in them – including the benefits of individual tax reliefs such as SEIS and EIS – are passed through to the underlying investors. This arrangement is very similar to a trustee relationship, as well as to the structures used by stockbrokers and other types of intermediary platform.

Benefits for investors

In the absence of a nominee arrangement, investors would hold the shares in each investee company directly as registered shareholders. It is difficult to overstate the problems this can cause when there is a multitude of investors, each making many small investments. Investors are left to manage the administration of their investments on their own, tracking corporate events, attending meetings and issuing consents where necessary. The bureaucratic hassle alone can be a pain, but the far greater problem is that there is no coordinated effort to monitor and enforce shareholder rights. And without this kind of coordinated effort, minority shareholders can easily fall prey to abusive actions by directors and the majority shareholders.

There are some who argue that this is addressed by investing only in entrepreneurs whom you trust. Unfortunately, that isn’t enough: as time goes by – especially if the company becomes successful – new management and investors may come into place, and they may act far less honestly toward the original shareholders. That’s why angel investors and VCs use and enforce subscription agreements when they make investments: no matter how honest the entrepreneur may be, his or her word simply isn’t enough once the company starts to grow. The worst thing that can happen to an investor is for the company to become hugely profitable, but for the investor not to realise the success because his or her rights weren’t protected along the way. And the risk of that happening is greatest when lots of small shareholders hold shares directly without anyone monitoring and enforcing their rights.

Our nominee structure addresses this. We get rid of the administrative hassle by taking care of all the technical shareholder work while letting investors track and engage with their investments directly through the platform. More importantly, by monitoring the company’s compliance with its subscription agreement, we help ensure that its investors’ rights are protected—so that when the company has a big exit one day, the investors get to realise the full benefit of it.

Benefits for startups

Because we act as nominee for the underlying investors, a startup needs only to deal with us for administrative matters like consents and shareholder votes. This is far easier from an administration perspective than having to send notices to, and even solicit approvals from, hundreds of scattered investors. At the same time, the startup can take full advantage of the invaluable feedback, experience and enthusiasm the investors can offer. So it is the best of both worlds: the administrative work only needs to be done with us, while the substantive support can come from all of the investors.

But this is not just about making entrepreneurs’ lives easy; it is also a critical element to ensuring that the startup can raise further funding down the line. Private company finance can be complex, and often various consents, waivers and other unanimous shareholder actions are needed for the company to raise additional money. If getting a consent depends on tracking down hundreds of investors all over the country (or the world), then as a practical matter the consent will never be obtained, and it is highly likely that the financing won’t be able to go through. As countless angels and VCs have told us, if they saw a widely-scattered shareholding base with no nominee in place, they would be deeply reluctant, or even entirely unwilling, to make an investment in the company.  The startup is dead in the water because its shareholding base makes it impossible to raise more capital.

Our nominee structure fixes this problem. We give the consent, sign the waiver or take whatever other action is needed to ensure the company can progress with its financing. It’s easy for angels, VCs and other later-stage investors to work with, which means that they’re happy to invest in a company that has been financed through Seedrs. That’s good news for the company and it’s good news for its investors.

It’s worth observing that all this isn’t a purely theoretical matter. Seedrs is less than seven months post-launch, but already one of our funded startups has achieved significant early success and is about to raise its next round of capital from a group of top-tier VCs. As usual, the VCs will only complete the deal if they receive certain consents from existing shareholders. We have reviewed their requests and think they’re reasonable, so we will sign them – simple as that. If the company had needed to chase down all of the individuals who invested in it through Seedrs, the consents would never be obtained, the deal would likely not go through, and this wonderful company would be stuck because it couldn’t raise the additional capital it needs.

Final thoughts

As crowdfunding has emerged in recent years, there has been a good deal of confusion between rewards-based and equity-based models. The former is about purchasing goods, the latter a type of investment, and while it’s obvious to some that these are very different things, many others treat them as one and the same.

One area where this confusion has been particularly pronounced is in the view that rewards crowdfunding and equity crowdfunding can work on the same structures and involve the same (lack of) interaction by the platforms after the funding is completed. The argument goes that on Kickstarter, a reward (such as a watch) gets shipped, and the platform has no further involvement – so in equity crowdfunding a share certificate can get shipped, and that’s the end of it.

But investing is very different from buying a product, and what happens after the deal is “completed” is far more complex when there is an investment involved. A different structure – one where the platform doesn’t just disappear from the picture, but instead takes the actions necessary to ensure that both investors and entrepreneurs benefit from the deal – is necessary. That, in a nutshell, is what the Seedrs nominee structure is all about.

Jeff Lynn

Jeff Lynn

I'm Executive Chairman and Co-Founder of Seedrs.

  • Richard Leinfellner

    New to this, so a couple of questions:
    1.) What safeguards are in place to ensure you are using your nominee powers with the shareholders interests taken into account?
    2.) How do you know what the majority of shareholders would want?
    3.) How do you protect against potential conflicts of interest?

    • seedrs

      Good questions Richard,

      This is why we believe our two layered fee structure is so important. We earn a fee on any profits our investors make on their investments (7.5% of returns over and above their original investment amount), so we are aligned with our investors and want them to do well.

      Beyond the upfront fee we take at the time of investment, we do not make any further fees from our portfolio companies during the life of the investment. Our fee for continuing to act as nominee comes only in the form of our carry on investor returns mentioned above.

      We have a consent committee set up within the company to consider any requests for consent that come in from portfolio companies. We consider all sorts of factors depending on the consent request at hand – the current situation of the company, the options available to it, what is standard practice in the market, how our investors will be affected by the decision at hand. It isn’t always practical to take account of the views of all investors, but we make the best decision we can on their behalf on the basis of the information available.

      With regard to conflicts of interest, we do our best at Seedrs to identify and manage conflicts of interest, and this is reflected fundamentally in our business model – we have aligned our interests with that of entrepreneurs and investors so that we earn money only when a company successfully funds and when an investor earns a profit off his or her investment. In addition, we highlight potential conflicts to our users our membership and campaign agreements, and have an internal policy on conflicts of interest that ensures that any potential or perceived conflicts of interest among Seedrs, its directors and employees, entrepreneurs and investors are minimised.

      Feel free to get in touch with support@seedrs.com if you’d like to discuss anything further.

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