Subscription Agreement: Everything to Know
A subscription agreement is between a company and a private investor to sell a specific number of shares at a specific price, documenting suitability.5 min read
What Is a Subscription Agreement?
A subscription agreement is between a company and a private investor to sell a specific number of shares at a specific price. This investor fills out a form documenting his or her suitability for investing in the partnership. A subscription agreement can also be used to sell stock in a privately owned business.
Subscription Agreement: What Is It?
The subscription agreement is used to keep track of how many shares have been sold and at what the shares sold at for a privately held company. The subscription agreement details all the information about the transaction, such as the number of shares and price, and confidentiality provisions.
Some agreements include a specified rate of return that investors are guaranteed to receive. That might be a percentage of the company's net income or it could be a specific amount in lump sums that are to be paid out on specific days.
Subscriptions agreements are most common with startups and smaller companies. They're used when business owners don't have the resources to work with venture capitalists or take the company public.
Why Are Subscription Agreements Important?
For companies that need more funding, it's a way to do it without taking a company public or finding venture capitalists to invest. Investors enter into a limited partnership, which basically means that they are silent partners. These investors are only obligated or expected to make a one-time investment. It limits the risk significantly but also limits the say investors have in company decisions.
Subscription agreements rely on SEC Rule 506(b) and 506(c) of Regulation D. The stipulations within those rules include how companies can or cannot solicit investors, what information is shared with investors, and who is allowed to invest.
Investing With Subscription Agreements: Advantages and Disadvantages
When it comes to investing, there are definitely some good and some bad to choosing to do so using subscription agreements.
- Subscription agreements provide a way to sell stock without registering securities with the Securities and Exchange Commission (SEC). Creating the prospectus needed for registering with the SEC is time-consuming and expensive.
- It's a one-time investment. Unlike venture capitalist investing, which requires much more time and typically multiple investments.
- It's not a huge time commitment since you're a silent partner in the investment.
- It's a limited partnership, so there's no worry about being liable.
- There are no voting rights and no way to help the business to be successful. You have to trust that the leadership of the business know what they're doing.
- Once you've invested your money, there's no way to get the money back if you change your mind.
Not Using Subscription Agreements: Advantages and Disadvantages
What if you decide to invest in other ways? Here are some pros and cons to investing, but not using subscription agreements.
- Although the private placement memorandum has a lot of information about the investment, a prospectus prepared for and approved by the SEC is more thorough. Therefore, it might be more helpful in deciding whether it's a strong investment.
- Investing with a company through a subscription agreement requires a large sum of money. However, investing in a public company allows you to use a smaller sum if you're unsure of whether it's a good investment.
- Investing in a private company allows you to get in on the "ground floor." You're able to invest before it goes public. If and when the company goes public, assuming it's successful enough to get there, it's very likely that the stock you own will be worth a lot more.
- Investing in a company with a subscription agreement means that you'll have access to the general partner to ask questions and really get to know the management team. You don't always get that with other types of investing.
Making the Agreement Too Complicated
While all the necessary legal information should be covered in this agreement, try to keep it as simple as possible. For example, you can include mention that the investor has read the private placement memorandum rather than repeating the information disclosed in the memo. This avoids potential confusion if the disclosures are paraphrased.
Not Getting Legal Counsel
Being a legal document, it's important to have a legal expert that specializes in finance to help you. A lawyer can explain to you all the legalese used in the contract and ensure that you agree with what's there.
For example, as an investor, you would want to know whether the money you invest will be kept in escrow. Then, once a specific amount of funds is raised, it's released to the seller. This ensures that if the funds aren't raised, the money is sent back to the investors.
Common Subscription Agreement Terms You Need to Know
An accredited investor is someone who fits one of the following:
- Has a net worth over at least $1 million excluding the value of a primary residence.
- Has income of at least $200,000 a year for the last two years (or a combined income of $300,000 a year if married) and a reasonable expectation of earning that much or more in the current year.
- An entity that has combined assets of more than $5 million.
Limited (Liability) Partnership
Limited partnerships, or limited liability partnerships, have less say in the management of a company. A general partner manages the business and has a hand in its direction. The general partner also has personal liability for debts and obligations. The limited partner, however, has limited liability, protecting them from debts incurred by the company.
A business agreement between two or more people who own a company together. All partners are legally liable for the actions of any of the partners, so there's financial risk when entering into a business partnership.
Sale of stock to a limited number of investors. These investors must be accredited, including proof of investment experience, number of assets, and net worth.
Private Placement Memorandum
The subscription agreement is included as part of the private placement memorandum. Companies provide these memos to investors. It takes the place of a prospectus.
Frequently Asked Questions
- What information is typically included in a subscription agreement?
The information in each agreement varies, but generally, the following information is included in a subscription agreement:
- Company information
- Expectations of both parties
- Agreement to subscribe (this includes the number of shares and price)
- Rights attached to the subscription
- Voting preferences
- Liquidation and redemption preferences
- Terms for termination before completion
- Nomination onto board
- Confidentiality provisions
- How the returns will be paid out
- Can I solicit investors?
In the past, to find investors to take part in the sale of stock by privately held companies, you could not solicit investors generally. However, in 2013 the SEC lifted the ban on general solicitation. This means that you can advertise that you're looking for investors, such as advertising online websites and through social media. Note though that the investors still have to be vetted to ensure that they are accredited investors. Only verified and accredited investors can be accepted as investors for your company.
There is, however, an exception made for equity crowdfunding. Those are considered different and have different requirements.
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