In 1975, an entrepreneur named Gary Dahl noticed people complaining about their pets. So he came up with an idea for the “best pet” ever –a pet rock. His pet rocks came with a carrier and a manual that gave helpful commands. Wikipedia says the manual
contained several commands that could be taught to the new pet. While “sit” and “stay” were effortless to accomplish, “roll over” usually required a little extra help from the trainer. “Come,” “stand” and “shake hands” were found to be near-impossible to teach; however, “attack” was fairly simple (also with some additional help from the owner).
The design of the product is awesome. I could actually see myself giving it as a gift. And in fact ~1.5M people bought it at $4, making Dahl ~$6M in revenue. Given his product cost pennies to make, Dahl became quite wealthy from his idea.
The success of Dahl’s product is a tribute to clever marketing. But I’m guessing very few pet rocks provided lasting benefit to their owners.
A lot of products can sell that are relatively useless. You can probably guess what I think about transfer agents for private companies.
Imagine you are a CFO of promising new startup and you get a sales pitch. It’s a company offering to end your cap table headaches. That would be amazing! Then to seal the deal the rep tells you: “You should work with us because we are the first and only SEC-registered transfer agent for private companies.”
Wow. That sounds official. Maybe it’s a right-of-passage for every startup on their journey to startup adulthood? Maybe it’s like getting your first driver’s license?
But here’s a little secret…
Private companies don’t need an SEC-registered transfer agent. They never have. 99% of private companies don’t have one now. 99% will never need a transfer agent at all but they often they need some help with transfer agent services. There are solutions that can give you the right amount of help without breaking the bank.
To understand what I mean, we need to understand what transfer agents do.
In this article, we’ll cover:
- What Transfer Agents Do
- Transfer Agent Companies
- How Public Companies Manage Their Equity
- How Private Companies Manage Their Equity
- How Private Companies Get Transfer Agent Services
- Should You Use A Transfer Agent
- How To Make Sure Your Equity Stays Your Equity
Transfer agents keep track of the individuals and entities that own a company’s stock. The word “transfer” refers to the exchange of company ownership. A transfer agent handles these transactions for company stock:
- assignments, or
They also help with things like voting on key issues, dividends, interest, etc.
The SEC defined transfer agents like this:
The term “transfer agent” means any person [or company] who engages on behalf of an issuer of securities or on behalf of itself as an issuer of securities in (A) countersigning such securities upon issuance; (B) monitoring the issuance of such securities with a view to preventing unauthorized issuance, a function commonly performed by a person called a registrar; (C) registering the transfer of such securities; (D) exchanging or converting such securities; or (E) transferring record ownership of securities by bookkeeping entry without physical issuance of securities certificates.
Among their key functions, [transfer agents] may: (i) track, record, and maintain on behalf of issuers the official record of ownership of each issuer’s securities; (ii) cancel old certificates, issue new ones, and perform other processing and recordkeeping functions that facilitate the issuance, cancellation, and transfer of those securities; (iii) facilitate communications between issuers and registered securityholders; and (iv) make dividend, principal, interest, and other distributions to securityholders.
So according to the SEC, basically any company that helps track and record share records is a “transfer agent.”
Keep in mind that transfer agent services are different than transfer agent companies.
This is a key point and bears repeating. Transfer agent services are different than transfer agent companies. You can get transfer agent services in many ways. Be wary of sales reps that imply you need to work with an “SEC-registered transfer agent” company. 99% of the time, this is false. We’ll show you the 6 cases where you might want a transfer agent company below.
Almost every company in the world needs transfer agent services at some point. For example, every company issues shares. There are ~7M companies with employees in the United States. But only ~4,000 public companies (0.1%) outsource these services to transfer agent companies. Almost every private company gets these services from a combination of in-house work, law firms, and software.
In the early days, banks handled transfer agent functions for most public companies. But over time, the volume of public company trading created the “Paperwork Crisis of the 1960s.” This made public companies want to outsource these services. The modern transfer agent company stepped in to offer these services.
Fun fact: The NYSE shut down every Wednesday in 1968 to keep up with the volume of paperwork.
99% of public companies use a transfer agent company. 99% of private companies don’t.
To understand the answer, we need to look at how public and private companies manage their equity.
It’s easy to get public company shares. All you need to do is open a brokerage account and then buy some shares.
But public companies don’t even know who most of their shareholders are.
Here’s a breakdown of Apple’s shareholders. When I wrote this article, there were 2,885 shareholders of Apple stock.
I would have guessed Apple had millions of shareholders. Why is the number so low?
Here’s the reason…
People hold shares in public companies indirectly through other entities.
Brokers can hold shares on behalf of a shareholder. And sometimes a centralized depository system called the DTCC (AKA, Cede & Co.) holds broker shares on behalf of the broker. So if you count indirect shareholders, Apple actually has millions of shareholders.
Most developed countries have a centralized securities depository. A centralized securities depository is a clearinghouse for all public security trades. The DTCC (also known as Cede & Co) is the centralized securities depository for the US.
Because the DTCC holds shares in every company, share trades can happen on the records of the DTCC. Let’s say I sell 10 shares of Apple to you. The DTCC can just change the name of the owner of 10 of the shares it holds from my name to your name. In practice, they’d probably use the names of our brokers, but you get the point.
This system decreases the number of direct shareholders of public companies. Millions of shareholders have public company shares through a small number of depositories.
I drew a little graph to help make sense of this.
Apple has a shareholder called Cede & Co. who holds 100 million shares. Cede & Co. knows your broker, Robinhood, owns 10 million shares of Apple. Other brokers own the other 90 million. And Robinhood keeps track of the fact that you own 100 shares of the 10 million that its clients hold.
Neither Apple nor its transfer agent know that you personally own shares. If they need to communicate something with you, they just send the information down the line.
It’s pretty complicated. But people are trading an average of 29 million Apple shares every day. This decentralized system simplifies record keeping.
Even with these simplifications, 29 million trades among 2,000+ shareholders can create a headache for Apple. It gets worse when Apple pays dividends or handles proxy voting. Most public companies don’t see this kind of shareholder tracking as core to their business. So they outsource it to traditional transfer agent companies.
Another reason involves liability. Small mess ups with public company stock can create millions of dollars of liability.
It’s hard to overstate one important difference between private and public companies. Private companies have far fewer shareholders. Unlike public companies, private companies are able to and want to track all of their shareholders.
Private company managers typically know every one of their shareholders personally. This makes it easier for these companies to:
- Raise money from investors (who are usually preferred shareholders in the company)
- Keep sensitive information private
- Use shares to motivate and retain top talent
- Minimize equity dilution
- Avoid complicated and costly securities regulation
You might wonder why private companies have so few shareholders. First, in the US, private companies are legally limited to 2,000 shareholders. Capshare data shows the average venture-backed company has 35 shareholders. Second, private company shares are hard to get. You have to 1) start the company, 2) be an employee at the company, or 3) be an accredited investor that knows the founders. Due to regulations, private companies also can’t broadly solicit potential investors.
Having fewer shareholders means private companies don’t need the most complex transfer agent services. For example, private companies almost never need proxy voting. They often don’t pay dividends at all. If they do, they usually only have to write a few checks.
Until recently, private companies used employees, law firms, and a spreadsheet to manage their shares. The spreadsheet is called a cap table.
Now, purpose-built cap table software, like Capshare, has replaced Excel spreadsheets.
Cap table management software (also known as equity management software) can:
- Issue electronic shares
- Maintain an always up-to-date register of shares
- Facilitate transfers, repurchase, exercises, sales
- Help with shareholder communication
- Manage compliance with private company equity regulations
If you could use these services, let us give you a demo of Capshare! We’d love to show you how we can help.
There are 4 ways private companies can get transfer agent services. The chart below compares the different approaches.
Let’s look at each of the options in more detail:
- Self-administer. This is where the company acts as its own transfer agent. It’s perfectly legal, but it does entail more work and risk if you mess something up.
- Cap table software. This is where the company acts as its own transfer agent but it uses software to help. Capshare, and competing systems, will track your shares and provide helpful warnings. For example, Capshare might alert you when issue more shares than you have authorized.
- Law firms. This is where the company uses a law firm for transfer agent services. The law firm and the company share liability for anything going wrong in the record keeping.
- Transfer agent companies. This is where the company uses a transfer agent company. The transfer agent company assumes most of the liability of keeping your records.
Many companies use a combination of these services. For example, Capshare frequently works with law firms. Morrison Foerster and DWT combine Capshare software with lawyers’ expertise. This allows them to give clients the best of software and services. So we work with a lot of companies that use our software + a law firm.
For the vast majority of private companies, the answer is an easy no.
Your private company is not legally required to use a transfer agent company except when:
- Your company is using Regulation CF to raise more than $10M in equity from more than 2,000 shareholders, or
- Your company is using Regulation A+ Tier 2 to raise equity
Click here to download our Crowdfunding Guide. The guide will help you navigate the choppy waters of crowdfunding. It will help you:
There are no other legal reasons to use transfer agent companies. If you want to adopt public company-level reporting, regulation, and costs–go for it! But most private companies don’t want to have to act like public companies unless they go public.
Full disclosure: Capshare is a cap table management company. But guess what? We are also an SEC-registered transfer agent! You can see our T1 here. Except in the cases above, we don’t believe it is in our clients’ best interests to act as their transfer agent company.
Here are 6 reasons a private company should consider using a transfer agent company:
- You have a high likelihood of going public within 24 months
- You have a very complicated equity structure and even software doesn’t work for you
- You have thousands of shareholders
- You want to put a buffer between your company and your shareholders
- You worry your law firm or cap table management software isn’t doing a good job
- You are a crowdfunded company.
As we mentioned, not every crowdfunded company needs a transfer agent. But they are necessary in certain cases. Barring these cases, it will add little value and a lot more cost to use a transfer agent company.
What kinds of costs?
Transfer agent companies often have to report to the SEC and go through regular audits. These take time and effort to pass. To be profitable, transfer agent companies pass on these costs to their clients.
Capshare’s fees generally tally to a thousand dollars per year for most companies. For crowdfunded companies with 10,000-20,000 investors, Capshare charges a lot more.
Worse, transfer agent companies often create high switching costs for their clients. We recently had a client switch to Capshare from a competitor. The competitor sent our client this message:
“Please provide us with your successor transfer agent’s name, firm name, contact name , contact phone, contact email, FINS# and TA #.”
This would be legitimate if our client needed to have a successor transfer agent. But 99% don’t have this legal requirement. In these cases, they can legally respond that they will be managing their equity without an SEC-registered transfer agent.
If you have a legal need to work with an SEC-registered transfer agent, we are happy to help! Click here to talk us about your needs.
There are few things more important to a private company founder or employee than the equity ownership they have in their company. There is almost nothing more hard-fought. So make sure you retain control of that equity. Transfer agents can be a good thing in a few exceptional cases. For the most part, private companies should manage their equity themselves. The best way to do that in our opinion is with market-leading software like Capshare, of course!