WALL STREET JOURNAL.
Startup Employees Invoke Obscure Law to Open Up Books
Delaware law is potentially valuable tool for employees and
investors who now question their shares’ worth
Shareholders are asking companies such
as Domo Inc. to open up their books. Above, a wall board in
Domo’s American Fork, Utah, office. PHOTO: JEFFREY D. ALLRED/THE
DESERET NEWS/ASSOCIATED PRESS
May 24, 2016 5:30 a.m. ET
For more than a year, Jay
Biederman has pestered Domo Inc. for its financial statements. The
former executive wants to estimate how much his tens of thousands of
shares in the tech startup are worth.
Domo, whose software
analyzes corporate data, has rejected those requests, he said, keeping
its financial records under wraps like most privately held startups.
But the law may be on Mr.
He recently discovered
section 220 of Delaware’s corporate law, which can compel locally
incorporated companies such as Domo to open up their books to
shareholders. The law, little known in Silicon Valley, is a
potentially valuable tool for thousands of tech workers who received
stock awards to join fast-growing startups, as well as other small
investors, who now question their shares’ worth.
To take advantage of the
law, stockholders must simply prove they own at least one share and
send the company an affidavit that states which documents they want
and why. The magic words for unlocking financial information? “ ‘For
the purpose of valuing my shares,’ ” says Michael Halloran, a
securities lawyer with Pillsbury Winthrop Shaw Pittman LLP.
Companies must then comply
or face the possibility of legal action. Shareholders are backed by
strong case law, say lawyers. To keep their financial data private,
companies often ask the shareholder to sign a nondisclosure agreement.
Valuations of private tech
companies are in doubt after years of hype and seemingly endless cash
from venture investors lifted values to new heights. Many of those
investors are now stepping back, pushing startups to deliver profit
over growth. Mutual-fund firms are marking down their stakes in some
startups, adding to the confusion. And the market for tech initial
public offerings is all but shut, another sign startups are
As companies stay private,
their financials remain concealed. Only top investors typically
receive periodic updates on revenue, profits and financial
Some highly valued
companies, such as software firm Palantir Technologies Inc. and
ride-hailing company Uber Technologies Inc., share little if any
information with smaller shareholders, say people familiar with the
matter. Spokeswomen for the two companies declined to comment.
Companies say keeping
their financial information private, even from some stockholders,
prevents it from falling into rival hands. The lack of public scrutiny
also gives them freedom to invest for the long term.
With at least 145 private
companies including Domo now valued at $1 billion or more, the
financial secrecy has caught the attention of the Securities and
Exchange Commission’s chairman,
Mary Jo White.
“Our collective challenge
is to look past the eye-popping valuations and carefully examine the
implications of this trend for investors, including employees of these
companies,” Ms. White said in a March 31 speech, while also raising
concerns about the accuracy and availability of financial information.
There have been hundreds
of Delaware lawsuits to inspect company books says Ted Kittila, an
attorney with Greenhill Law Group. Most requests are settled before a
suit is filed, he says.
Some companies are now
pushing employees to waive their right to inspect the books as a
condition for receiving stock awards, says Richard Grimm, an executive
compensation attorney. Fitness tracking company
and online dating site Zoosk Inc.
both did so as private companies, according to their IPO filings.
Fitbit declined to comment. Zoosk didn’t respond to questions.
“It’s unclear whether this
kind of waiver would be supported” in court, Mr. Grimm says.
Option holders at some
larger private companies are supposed to receive financial information
upon request, according to an SEC rule. It is unclear whether all
private tech companies covered under the rule are complying, lawyers
Chris Biow, a former
executive and shareholder at MarkLogic Inc. and MongoDB Inc.—two
software startups valued at over $1 billion—says he regularly
discusses Delaware inspection rights with groups of employees for each
“We have all these
‘unicorns,’ where it’s not clear what year or decade they may go
public,” said Mr. Biow, now a senior vice president at Basis
Technology Corp., using a tech industry term for private companies
valued over $1 billion.
Mr. Biow said he wants to
know the revenue and profits as well as the list of stockholders,
which may be the only possible buyers of his shares as private
companies often restrict sales to new investors.
San Carlos, Calif.-based
MarkLogic, valued at $1 billion by investors a year ago, eventually
agreed to let Mr. Biow view its financial results in its office in
2014, though it has refused to share a full stockholder list, he said.
A MarkLogic spokesman said
the company’s practice “is to be forthcoming with our financial
information for any shareholder that makes a proper request to the
Mr. Biow only recently
exercised his MongoDB stock options so he hasn’t yet asked the New
York company for information.
Meanwhile, Mr. Biederman,
who left Utah-based Domo in February 2015 after four years, says he is
still trying to get information from the company. This January, Domo’s
treasurer denied access, saying it wasn’t sharing financial data with
stockholders, Mr. Biederman said. A month later he submitted an
affidavit citing his rights under Delaware law.
Since he filed the
affidavit, two divergent signals have exposed the difficulty in
valuing his shares. In February, Fidelity Investments marked down its
Domo shares to $5.03 a share, 40% below where the company previously
sold shares that equated to a $2 billion valuation. A few weeks later,
in March, Domo said it raised more capital at the same $2 billion
valuation, and Fidelity subsequently marked its shares back up to
$8.43 a share.
Then last week, trading
firm EquityZen Inc. sponsored an offering to buy shares from employees
at $6.36, according to a presentation reviewed by the Journal. An
EquityZen spokesman declined to comment.
Mr. Biederman, who last
year exercised his options at 32 cents a share, said the company has
asked him to sign a nondisclosure agreement before sharing financial
information. He says Domo has yet to send it to him.
A Domo spokeswoman
declined to comment.
Rolfe Winkler at
Own Startup Shares? Know Your Rights to Company Financials
May 24, 2016 5:30 a.m. ET
Privately held startups
have fewer disclosure requirements than their publicly traded
counterparts. But in the eyes of their employees and shareholders,
private companies shouldn’t be so private.
At least three laws
require startups to disclose financial information to their
stockholders, but lawyers say many don’t comply. Here’s what
shareholders need to know.
Corporations Law, Section 220
law gives shareholders of companies
incorporated in the state the right to inspect a company’s books
and records, which can include a list of stockholders, financial
statements, articles of incorporation and more.
Since most tech companies
are incorporated in Delaware, this law applies to most venture-funded
Ted Kittila, a Delaware
lawyer at Greenhill Law Group, says the following steps should enable
shareholders to inspect financial information to help value their
Prepare an affidavit that
•That you are a
shareholder. Options don’t count, though exercising one option to buy
one share does.
•The reason to inspect the
company’s books. Delaware courts have said one legitimate reason is
“for the purpose of valuing my shares.”
•The requested documents.
Stockholders might request a balance sheet, income statement and
cash-flow statement to analyze the company’s business. They might also
request a stockholder list to determine how many shares are
outstanding to calculate their percentage ownership.
Companies have five days
to respond. If the company doesn’t reply or rejects the request,
shareholders can file a lawsuit.
A negotiation typically
ensues, including a demand by the company that the shareholder sign a
nondisclosure agreement. If both parties agree, the company should
disclose the documents.
Mr. Kittila says
shareholders could expect to pay about $5,000 in legal costs to draft
a legal letter and negotiate with the company, or more if a lawsuit is
filed. Shareholders may increase their odds of success, and share
legal costs, by teaming up with one another on the same request, he
Code, Section 1501
obscure California law requires
larger startups based in the state to send an annual report with
financial statements to all shareholders.
Section 1501 applies to
all companies with headquarters in California, whether or not they are
incorporated in Delaware, says Keith Bishop, the state’s former
commissioner of corporations, now a corporate attorney at law firm
Allen Matkins. The exception is for companies with fewer than 100
shareholders who waive the requirement in their bylaws.
That means the law likely
encompasses dozens of private technology companies valued north of $1
billion, as well as hundreds of smaller tech startups.
The law states the annual
report should include a balance sheet as of the end of the fiscal
year, and income and cash-flow statements for that fiscal year.
Lawyers say most companies
ignore the law because they either aren’t aware of it, or they don’t
want to share their information. Penalties for violating it top out at
$1,500, Mr. Bishop said.
Companies are supposed to
send their annual report within 120 days after the end of its fiscal
year. If they don’t, Mr. Bishop makes the following recommendations:
•Shareholders should send
a letter requesting financial statements, citing Section 1501(a) of
the California Corporations Code. Include a return receipt for proof
of delivery. The company is required to send financials within 30
days, if the request is made more than 120 days after the fiscal
•A shareholder, or group
of shareholders, owning at least 5% of the company can also request
interim financial statements.
•If the company refuses to
provide financials, a shareholder will have to hire a lawyer and file
•Shareholders should keep
track of expenses like attorney’s fees because the court may force the
company to pay them if it finds it withheld financial statements
Federal Securities Act of
1933, Rule 701
Many tech startups lure
new hires with stock options, letting them buy shares at a specified
price. But it can be daunting for option holders to figure out when
and whether to exercise the shares.
this federal securities rule,
option holders at some larger private companies are entitled to
receive detailed financial information when deciding whether to
exercise the options. This includes financial statements, risk factors
This provision to provide
information is part of a larger rule that helps companies stay private
by exempting stock awards from being registered publicly. But if a
company’s stock awards eclipse $5 million in any 12-month period, the
provision is triggered. Many “unicorn” companies, or those valued at
$1 billion or more, have passed this threshold, say lawyers.
Google and its general
David Drummond, got into hot
water with the Securities and Exchange Commission in 2005 for
violating this rule when it was a private company.
Google settled with the SEC by
agreeing to abide by the law in the future.
When complying, companies
often give employees access to a password-protected website with
financial information. Option holders are often required to sign a
nondisclosure agreement first, says Daniel Neuman, an attorney with
Carney Badley and Spellman.
Former employees holding
options are also included under this rule, but lawyers say many
companies refuse to provide information to them. People who have left
or been fired typically have 90 days to exercise vested options or
Lawyers recommend options
holders ask the company if it is required to make disclosures under
rule 701, and request additional information if so.
If the company rejects the
request, option holders can file a complaint with the SEC by
emailing or filling out a