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Richard - Bizlaw
Richard - Bizlaw, Attorney
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Experience:  30 years of corporate, litigation and international law
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We have a question about a Private Pacement Memorandum. If

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We have a question about a Private Pacement Memorandum. If we have issued some amount of stock and some warrants or options, we understand we would disclose this as outstanding stock (fully diluted) when doing a cap table in the PPM. What is the status of additional warrants or options that are being promised in an employment agreement to be issued at the end of each year for x number of years based upon achieving milestones or performance goals? Would these have to be disclosed in a cap table or do these not count since they have not been issued yet and won't be until the goals are met? In the agreement can the strike price be set in advance at a low number? Is there a difference in how you would disclose warants/options already issued at the time of the PPM but vesting over time (say 25% of the total each year over 4 years), and just a promise in an agreement that warrants / options will be issued later? Or if the warrant/option has been issued at the time of the PPM is it counted regardless of when it vests? Or if there is an agreement to issue warrants/option in the future does that count now or only later when issued?

Richard :

Hello, I will try to help you. Please remember I just report or interpret the law, so the outcome may not be what you hoped for. when you say can the "strike price be set in advance" I am not clear about what you are speaking. Are you talking about the exercise price of the warrants or options that you have already agreed to issue? What are the terms of the employment based warrants/options that have been promised in the future?


Yes - the exercise price on the warrants which would be set in advance in an employment agreement. The terms would be something like x amount of additional warrants/options at the end of each year for the next four years, if goals are met. Goals might be sales numbers, product approval by the FDA, etc.


Our concern is that an investor(s) might not want to see too much stock outstanding. We are talking about the founders and management team having about 50% and the investor the other 50%, but the founders and management team would have agreements that get them a lot greater share of the stock over the coming years if milestones are accomplished, or exceeded. In this way the investors might end up with more like 20 - 25% once the company is sold or does an IPO. We have a plan for the ultimate dilution of the ownership - what we think it should look like but are not sure this must be disclosed in the early stages - if the warrants/options have not actually been issued then it is not a reality yet. So we think we could accurately report that we are giving away 50% of the company at the time of the investment. The founders would rather get their stock up front and the management team would rather have their options in hand even if they have not vested yet, but then we think the amount of stock we would have to report (fully diluted) might turn investors off. Another way of putting it is that if the founders and management team had 75% of the stock and gave the investors 25% for say $5 million, the the company would have a post investment value of $20 million which is too high. Assuming a $1 per share stock price for the investment, if the founders/management team only had $5 million shares that were issued, and the investors bought another 5 million shares, the post invest ment valuation would be $10 million (or the pre-investment value of the company would be $5 million) which is about right.


We want to know if we can say only 5 million shares are issued (either in stock or warrant/options) even though we have agreed to give away a lot more in the employment agreements, but only if goals are met. Do we have to include what we have agreed to in the employment agreements in a capitalization table? or could they just be footnoted if they need to be mentioned at all?

Richard :

You must disclose the warrants and options that are reserved for issuance to employees in the future. So if 25% is being reserved for issuance in the future at strike prices equal to fair market value that reservation of warrants and options must be disclosed in the PPM otherwise you will have a material misrepresentation. Any additions to the warrants and options reserved for employees in the future is to done by board resolution and shareholder resolution. If your plan is not going to be acceptable to investors then you need to reduce what you are giving to employees because full, accurate disclosure is the requirement. If I have answered all your questions, please rate my answer excellent as that is how I am compensated. If you have more questions, please let me know. If the answer was especially helpful you can provide a bonus.

Richard - Bizlaw and 3 other Business Law Specialists are ready to help you
Hi Howard

I'm just following up with you to see how everything is going. Did my answer help?

Let me know,if you have any more questions.

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