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Obscure Delaware Law Could Force Small Biz to Open Books

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By Christopher Coble, Esq. on June 24, 2016 11:59 AM

In today's small biz world, many startups, especially Silicon Valley-based tech companies, are asking early employees to forgo high salaries in favor of shares in the company, essentially betting on their own future success. Such equity arrangements can be great for employees and entrepreneurs alike, but they may come with a snag: how can new employee-shareholders find out how much of the company they're getting and how much their shares are worth?

For publicly traded companies, it's easy -- check the share price. But for privately held startups getting that kind of information is more difficult, if not impossible. But an oft-overlooked Delaware incorporation law may be opening the books to shareholders. Here's what you need to know:

Inspect for Any Proper Purpose

Neatly tucked away in Delaware's corporate statutes is Section 220, which states in part:

Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:
(1) The corporation's stock ledger, a list of its stockholders, and its other books and records; and
(2) A subsidiary's books and records

The law wouldn't be that important if not for two facts: (1) a whole lot of companies, even Silicon Valley tech startups, are incorporated in Delaware; and (2) a whole lot of companies, especially Silicon Valley tech startups, pay their employees in company shares.

Given those two facts, however, Section 220 can be an important tool for employees and other shareholders to force open a company's books and get a peek inside. Michael Halloran, a securities lawyer with Pillsbury Winthrop Shaw Pittman LLP, told The Wall Street Journal that all shareholders need to say is that the inspection is "For the purpose of valuing my shares," and it's Open Sesame.

Waive Goodbye

Small business owners worried about sharing high-level financial information with employees can always have them sign non-disclosure agreements. And some more creative companies are asking employees to waive their right to inspect the books as a condition of stock awards. But whether such waivers would hold up in court is another matter altogether.

So if secrecy is your thing, you may want to consider sticking to cash compensation for your startup employees. That, and staying out of Delaware. Or you may want to give an experienced corporations attorney a call for advice.

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