NOTE: This article is for general information only and is not a comprehensive discussion of the topic.  This article is not legal advice and should not be relied upon for any legal matter.  You are urged to consult your attorney for more information on the topic discussed below.  Please see the Disclaimers at the end of this article.
 
Starting January 1, 2023, most privately owned corporations, LLCs, limited partnerships, LLPs and other companies, as well as the officers, directors, managers, general partners, and 25% owners of these companies, will be subject to new federal reporting requirements imposed by the Corporate Transparency Act.  This article provides an overview of this new, onerous law.

1.  Overview
The Corporate Transparency Act (the “CTA”) was enacted in 2021 as an expansion of federal laws that combat money laundering, terrorist financing, tax fraud and other illegal activities.  The CTA requires “reporting companies” to provide the federal government with information on certain “beneficial owners” and “company applicants.”  The governmental agency tasked with implementing the CTA is the Financial Crimes Enforcement Network, or FinCEN, which is a bureau of the Department of Treasury.  FinCEN’s website is found at www.fincen.gov.  The CTA becomes effective on January 1, 2024.
 
The information reported to FinCEN will be confidential and maintained in a non-public database maintained by FinCEN.  The information may be shared by FinCEN with federal and state law enforcement agencies, foreign law enforcement agencies, the Department of Treasury (including the IRS), foreign law enforcement agencies and financial institutions.
 
The CTA is an onerous and complicated law.  While this article provides an overview of the CTA, you are urged to review the CTA’s requirements with your attorney.
 
At the end of this article there are links to resources regarding the CTA.
 
2.  Impact and Burden
FinCEN estimates that over 32 million domestic and foreign companies will be required to report beneficial ownership information under the CTA when it becomes effective on January 1, 2024, and that five million new companies formed each year will meet the definition of Reporting Company.  FinCEN also estimates the time required to complete the report to range from 90 minutes for the simplest of companies to approximately 650 minutes (almost 11 hours) for more complex entity structures.  The bottom line is that a massive number of companies will be required to comply with this burdensome law.  There are also penalties for non-compliance.
 
3.  Framework
The CTA requires:

• Reporting Companies;
• To identify Beneficial Owners and Company Applicants;
• To collect information from them;
• And report that information to FinCEN;
• Within certain timeframes;
• Or penalties may apply.

 
Let’s explore each of the above elements, starting with understanding what is a “Reporting Company.”
 
4.  Reporting Companies
Generally speaking, many privately-held companies fall within the definition of a “Reporting Company.”  There are two types of Reporting Companies: Domestic Reporting Companies and Foreign Reporting Companies.  There are also many exemptions from being a Reporting Company.
 
Domestic Reporting Companies.  A “Domestic Reporting Company” is any entity that is created by the filing of a document with a secretary of state or a similar office under the law of a state or an Indian tribe.  Domestic Reporting Companies include:

• Corporations, including venture capital-backed companies and professional corporations.
• Limited partnerships, including those formed as venture capital, private equity or real estate funds or projects;
• Limited liability companies (LLCs), including those formed by investors to hold investments or real estate, or those formed to be operating companies (including consulting companies);
• Limited liability partnerships (LLPs), including those formed by law firms; and
• Other entities formed by filing a document with a state, including certain business trusts.

 
Note that all of the above companies are formed by filing a document with a state or Indian tribe.  Because the CTA covers only companies that are formed by filing a document with a state or Indian tribe, the CTA does not appear to cover sole proprietorships or general partnerships, as these types of companies aren’t formed by filing a document with a state.
 
Foreign Reporting Companies.  A “Foreign Reporting Company” is any entity formed under the law of a foreign country, and registered to do business in any U.S. state or in any tribal jurisdiction by the filing of a document with a secretary of state.
 
Exemptions from Being a Reporting Company.  There are many exemptions from being a Reporting Company.  These include:

• Publicly-traded companies;
• Any “large operating company” which (1) employs more than 20 full-time employees in the US, (2) has an operating presence at a physical office in the US, and (3) has over $5 million in annual gross receipts or sales;
• Certain venture capital fund advisers;
• Certain accounting firms;
• Certain companies registered or chartered with the federal government, including certain banks, credit unions, other financial institutions, Broker-Dealers (such as investment banks and stock brokerages), investment companies and investment advisers; and
• Certain tax-exempt entities, including certain 501(c)(3) organizations;

There are more exceptions, but these are the main ones.  You should consult your attorney to determine if an exemption is available.
 
Also, as noted above, sole proprietorships and general partnerships are not covered by the CTA.
 
Once it is determined that a company is a Reporting Company and no exemption applies, the next step is for the Reporting Company to identify its Beneficial Owners and Company Applicants.
 
5.  Beneficial Owners and Company Applicants
The CTA requires Reporting Companies to identify Beneficial Owners and Company Applicants, to collect certain information about them, and to report this information to FinCEN.
 
Beneficial Owners.  A Beneficial Owner is generally any individual who directly or indirectly exercises “Substantial Control” over the Reporting Company or who owns or controls at least 25% of the ownership interests of the Reporting Company.  Stated another way, an individual is a Beneficia Owner if they directly or indirectly:

• Exercises Substantial Control over the Reporting Company; OR
• Owns or controls at least 25% of the ownership interests of the Reporting Company.

We will look at these in turn.
 
Substantial Control.  An individual directly or indirectly exercises Substantial Control over a Reporting Company if the individual:

• Is a “senior officer” of the Reporting Company.  A “senior officer” is a chief executive officer, president, chief financial officer, general counsel, chief operating officer, or any other officer who performs a similar function regardless of their title.
• Can appoint or remove any senior officer or a majority of the board of directors or similar body.
• Has substantial influence over important decisions made by the Reporting Company, including the sale or merger of the Reporting Company, major expenditures, issuances of equity, incurrence of significant debt, approval of the operating budget, amendments of governance documents, and more.

 
Substantial control can be exercised directly or indirectly, such as through:

• Representation on the board of directors (or other similar body)
• Owning or controlling a majority of the voting power or voting rights of the Reporting Company
• Rights associated with financing agreements.  In many financing agreements, such as venture capital financing agreements, investors typically have the right to appoint one or more of the directors, and the company typically has to obtain the consent of investors to do certain actions.  The rights granted to investors under these agreements may be “substantial control” over the Reporting Company.

Whether an individual exerts substantial control depends on the facts and circumstances of the situation, and an attorney should be consulted on this determination.
 
Owns or Controls 25% of the Ownership Interests of the Reporting Company.  An individual is deemed to be a beneficial owner if the individual, directly or indirectly, owns or controls at least 25% of the “Ownership Interests” of the Reporting Company.  The definition of ownership interests is complex, but the basics are as follows.  An “ownership interest” is:

• Any equity, stock, joint venture interest, certificate of interest in a business trust, regardless of whether the interest is voting or non-voting.
• Any capital or “profit interest” in an entity (this includes ownership interests in an LLC or limited partnership; profit interests are common incentive compensation vehicles for LLCs).
• Any instrument that converts into any of the above, such as a convertible note, a Simple Agreement for Future Equity (SAFE), convertible preferred stock, options, warrants, and the like.
• Certain puts, calls, straddles and other similar instruments.
• Any other instrument or arrangement used to establish ownership.

There’s more to this definition, but the above provides the basics.
 
Note also that if a 25% owner of a Reporting Company is itself an entity, then the CTA appears to require the Reporting Company to obtain from this 25% owner the beneficial ownership information for that 25% owner and submit this information to FinCEN.  This is because of Reporting Company must report direct or indirect Beneficial Owners.
 
Calculating the Total Ownership Interests.  The calculation of the 25% ownership interest is also complicated, but for corporations the percentage of ownership is the greater of:

• The total combined voting power of all classes of ownership interests owned by the individual as a percentage of the total outstanding voting power of all classes of ownerships; and
• The total combined value of the ownership interests of the individual as a percentage of the total outstanding value of all classes of ownership interests.

In addition, any options or similar instruments are to be treated as exercised.
 
Company Applicants.  The CTA also requires Reporting Companies to report information on “Company Applicants.”  The definition of Company Applicant is different for Domestic Reporting Companies and for Foreign Reporting Companies.

• For a Domestic Reporting Company, a Company Applicant is (1) an individual who directly files the document that creates the Domestic Reporting Company, and (2) the individual who is primarily responsible for directing or controlling the filing if more than one individual is involved.
• For a Foreign Reporting Company, a Company Applicant is (1) an individual who directly files the document that first registers the Foreign Reporting Company with a state or tribunal, and (2) the individual who is primarily responsible for directing or controlling the filing if more than one individual is involved.

 
Practically speaking, a Company Applicant is the person who does the filing and any person who directs the filing.  This can be an attorney who formed the company, a person who makes the filing on their own (as many entrepreneurs do), or the person supervising the filing.  The CTA only requires that Company Applicants for Reporting Companies formed on or after January 1, 2024 to be reported.
 
Now that we know what a Reporting Company is, and who is a Beneficial Owner, let’s turn to the information that must be collected by the Reporting Company and submitted to FinCEN.
 
6.  Information Required to be Collected and Reported to FinCEN
The Reporting Company must collect and report information on itself and on each Beneficial Owner.
 
Reporting Company Information.  The information required to be reported by the Reporting Company includes:

• The full legal name of the Reporting Company;
• Any trade name or “doing business as” (DBA) name of the Reporting Company;
• If the Reporting Company has a principal place of business in the US, the street address of the Reporting Company’s principal place of business, otherwise the street address of the primary location in the US where the Reporting Company does business;
• The state, tribal, or foreign jurisdiction of formation of the Reporting Company, and for Foreign Reporting Companies, additionally the state or tribal jurisdiction in the US where the Foreign Reporting Company first registered.
• The taxpayer identification number (TIN) including the Employee Identification Number (EIN) for a Domestic Reporting Company, and for a Foreign Reporting Company a tax identification number issued by a foreign jurisdiction and the name of the jurisdiction.

 
Beneficial Owner and Company Applicant Information.  In addition to the above, a Reporting Company must also collect the following from each individual who is a Beneficial Owner or a Company Applicant:

• The individual’s full legal name;
• Date of birth;
• Residential street address;
  • For Company Applicants who form or register entity in the course of their business (such as attorneys and entity formation companies), the street address of such business;
• A unique identifying number and issuing jurisdiction from one of the following:
  • A current driver’s license and state of issue;
  • A current US passport;
  • Aa current personal identification document issued by a state, local government, or Indian tribe (such as an ID card issued by a state);
  • For foreign individuals who don’t have a US driver’s license, a US passport or a personal identification document, a current passport number from a passport issued by a foreign government to the individual; and
• An image of the document from which the unique identifying number was obtained.

 
Reporting Companies don’t have to collect or report information on Company Applicants for companies formed before January 1, 2024.
 
There are also special rules for the following:

• Reporting companies owned by an entity that is exempt from the CTA’s reporting requirements (see above for exemptions from the CTA);
• Minor children; and
• Foreign pooled investment vehicles, such as foreign mutual funds, hedge funds and private equity funds.

 
FinCEN Identifier.  The CTA allows individuals to request a unique identifier from FinCEN (a “FinCEN Identifier”) so that they can provide this FinCEN Identifier to Reporting Companies in lieu of providing the required beneficial ownership information to the Reporting Company.  To obtain a FinCEN Identifier, the individual will be required to submit the beneficial ownership information directly to FinCEN via an online form.  Once a FinCEN Identifier is issued to an individual, the individual can provide the FinCEN Identifier to a Reporting Company in lieu of the required information.  This seems to provide individuals who obtain a FinCEN Identifier with a certain amount of privacy in that they provide the FinCEN identifier to a Reporting Company and not the required beneficial ownership information.  Note that the individual is responsible to keep the beneficial ownership information submitted to FinCEN up to date, or potentially face penalties and fines.  Any changes to the beneficial ownership information reported to FinCEN must be updated within 30 days after the date the change occurs.  Note that Reporting Companies may also request a FinCEN Identifier.
 
Reporting the Information.  The beneficial ownership information will be reported to FinCEN via an online form.  The details on the form have not yet been finalized.  Essentially, Reporting Companies will collect the beneficial ownership information and upload that information via the government website.
 
7.  Timeframes
 
Filing of Initial Report.  The timeframes for filing the initial beneficial ownership information (BOI) report are different for Reporting Companies formed prior to January 1, 2024, and those Reporting Companies that are formed on or after January 1, 2024.
 
For those Reporting Companies formed prior to January 1, 2024, the initial BOI report must be filed not later than January 1, 2025.  Thus, companies formed prior to January 1, 2024 have a full year to comply with the CTA.
 
For those Reporting Companies formed on or after January 1, 2024, the report must be filed within 30 days after the date that the secretary of state or other similar office provides notice that the Reporting Company has been created.  This will most commonly be the date that the articles of incorporation, certificate of incorporation, articles of formation or other similar documents are file-stamped by a secretary of state as being formed.
 
Updates.  The BOI reported to FinCEN must be kept up to date at all times.  Any changes (even small changes) to the BOI must be updated by the Reporting Company within 30 days after the change occurred.  The update requirements apply if an individual who is a beneficial owner of a Reporting Company dies, or a minor child becomes an adult.
 
Exempt Entities.  If an exempt entity (such as a public company) no longer meets the requirement for an exemption from the CTA, then that entity must file a report within 30 days notifying FinCEN that it no longer meets an exemption and to report the BOI to FinCEN.  Similarly, if a Reporting Company has filed its initial report with FinCEN and later qualifies for an exemption from the CTA, then that Reporting Company must also file a report with FinCEN to that effect within 30 days of qualifying for the exemption.
 
8.  Penalties
Failure to comply with the CTA can lead to criminal and civil penalties.  If an individual or Reporting Company willfully (voluntarily and intentionally) violates the CTA by either providing false beneficial ownership information, failing to report complete information or failing to update the beneficial ownership information, then they are subject to (1) a $500 per day civil penalty for each day the violation continues, and (2) may be fined not more than $10,000, imprisoned for up to two years, or both.  There are additional penalties for any person who knowingly discloses the beneficial ownership information in a report submitted to FinCEN or who knowingly discloses information provided by FinCEN.
 
Concluding Comments
The CTA is an onerous and complex law that requires most privately-held companies to report information on themselves and on their beneficial owners and company applicants.  You are urged to consult with your attorney to determine whether the CTA applies to your company and if so, the information that needs to be collected and submitted to FinCEN.
 
Resources:
FinCEN Beneficial Ownership Reporting Resource page:
https://www.fincen.gov/boi
 
Corporate Transparency Act (31 U.S. Code §5336):
https://www.law.cornell.edu/uscode/text/31/5336
 
Rule on Beneficial Ownership Information Reporting Requirements
https://www.federalregister.gov/documents/2022/09/30/2022-21020/beneficial-ownership-information-reporting-requirements
 
Proposed Rule on Collection of Beneficial Ownership Information:
https://www.federalregister.gov/documents/2023/01/17/2023-00703/agency-information-collection-activities-proposed-collection-comment-request-beneficial-ownership
 
Proposed Rule on FinCEN Identifiers:
https://www.federalregister.gov/documents/2023/01/17/2023-00708/agency-information-collection-activities-proposed-collection-comment-request-individual-fincen
 
 
LEGAL DISCLAIMER: ATTORNEY ADVERTISING
This article is considered advertising under applicable California law and may be considered advertising under other state's laws and ethical rules.  This website and its contents are offered for informational, promotional purposes only and is not legal advice. Information in this article may be incorrect, incomplete or out of date.  Please see the "DISCLAIMERS" page for additional disclaimers.

I am pleased to be moderating a panel at the upcoming Opal Family Office & Private Wealth Forum West conference, being held from October 20-22, 2021 at the Napa Valley Marriott Hotel & Spa.  I will be moderating the panel "Investing in Innovative & Cutting Edge Technologies: Direct, Co-Invest and Funds."

The conference website can be found here: https://opalgroup.net/conference/family-office-private-wealth-management-forum-west-2021/

Once an investor has decided to invest in startup through a preferred stock financing, such as a Series A preferred stock financing, the company and the investor will negotiate the principal terms of the financing in a non-binding “term sheet.”
 
Term sheets define the rights, privileges and preferences of the investors in the preferred stock financing.  Term sheets can be daunting for investors new to venture capital financings.
 
I have prepared an annotated term sheet for a Series A preferred stock financing, which provides an overview of the key terms as well as links to blog posts relating the topics in the term sheet.
 
The term sheet can be obtained below:

Please let me know if you have any suggestions on how to improve the term sheet.

© Allen J. Latta.  All rights reserved.

 
In a prior post, “Pre-Money and Post-Money Valuation,” we introduced the basics of pre-money valuation and post-money valuation and how they are related.  This post expands that post to discuss the impact of option pool refreshes on pre- and post-$ valuations.
 
In the prior post, we looked at FlintRubble.com which was formed by Wilma and Betty.  The two founders invested $5,000 each and received 50,000 shares.  After the issuance, the ownership looks like this: 

​Simple Agreements for Future Equity, known as “SAFEs,” are a popular financing tool for seed and early-stage companies.  Developed by the well-known startup accelerator Y Combinator in 2013, SAFEs have become a standard financing tool for startups.
 
SAFEs have some similarities to convertible notes, but are very different.  We discussed convertible notes in the post “Convertible Notes: An Overview.”  I recommend reading that post before continuing reading this post.
 
Let’s dive in.

​Convertible notes provide start-up companies with cash to operate the business until the company can raise a more formal financing round.  Convertible notes and their cousins, Simple Agreements for Future Equity, or SAFEs, are popular “bridge” financing strategies for start-ups, and have grown in use over the past few years.
 
This post explores convertible notes.  A future post will explore SAFEs.

​Warrants to purchase stock in private companies enable the holder of the warrant to buy shares of stock in the company at a specified price for a certain period of time.  Warrants are issued by private companies to investors, lenders, vendors and partners as part of a transaction or as an incentive to enter into a transaction or a financing. 
 
Warrants are very flexible agreements and can be customized for a particular situation.  This post provides an overview of private company warrants.

​Imagine being an early employee of a startup and being granted stock options as part of your compensation package.  A few years later the company goes public and your stock options are worth several million dollars.  This is a story that has been repeated many times the start-up world.
 
Stock options provide a way for officers, directors, employees and consultants to share in the upside in the equity value of a company.  Companies issue stock options to attract and retain talent, and to reward these people with upside in the company’s value.  Investors in start-ups recognize the value of stock option plans, and make sure the company will have a suitable stock option plan in place to attract and retain top-level talent.
 
This post provides an overview of stock option plans.

​Drag-along rights enable a group of stockholders (such as a majority of the preferred stockholders) to force a sale of the company.  These rights are called “drag along” because the stockholder group exercising the right are in effect dragging the other stockholders along in the transaction.
 
Why do preferred stock investors in start-up companies (such as venture capital firms) want these rights?  To ensure that if the preferred stockholders want to sell the company, they can.
 
Drag-along rights are a bit complex, and this post will try to demystify them.

​In the prior post “Preferred Stock Financings: Rights of First Refusal” we discussed the right that the company and stockholders have to acquire the shares of stock being offered for sale by an existing stockholder.
 
A related right is the Co-Sale right, also known as “tag-along” right or “take me along” right.  A Co-Sale applies when an existing preferred stockholder in a privately-held company has received an offer from a potential buyer (known as a “third party”) to buy its stock.  The Co-sale right enables existing stockholders to sell their stock alongside the selling stockholder in this transaction.
 
Let’s explore the mechanics of a Co-Sale right.

Have you heard the term “ROFR” (pronounced “Roafer”)?  This term is well known by professional investors.
 
ROFR means Right of First Refusal.  We will do a deep dive on ROFRs in this post.

​This post is a continuation of the post “Preferred Stock Financings: Registration Rights Part 1.”
 
In the prior post, we discussed the registration process, which enables the company and/or existing stockholders to sell shares to the public on a stock exchange, such as the New York Stock Exchange (“NYSE”) or NASDAQ.  We discussed S-1 registration statements and S-3 registration statements, which are the primary ways for the company to sell stock to the public.
 
In this post, we explore “demand” registration rights and “piggyback” registration rights, which are rights held by the preferred stockholders in order to be able to register their shares so they can be sold in the public markets.

​There are two key events that occur for an investor in a private company:  The purchase of the stock and the exit (an “exit” is the sale or exchange of the stock for cash or publicly traded stock).  The primary exits are when a company is sold and the investor receives cash for its stock, and when the investor sells their shares into the public market as part of a registered offering, such as an IPO.
 
“Registration rights” are the rights that preferred stock investors obtain to allow them to sell their stock in a registered offering. 

​There’s a lot to discuss here, so buckle up and let’s get going.

I am pleased to be moderating a panel at the Carmo Middle Market Private Equity Web Conference on February 9-10, 2021.  I will be moderating the panel "Consumer & Business Services: A Conversation on Value.  The link to the conference is here: ​https://www.carmocompanies.com/middle-market-private-equity-web-meeting

When you buy stock of a publicly-traded company, there's lots of information available about the company's business and finances.  This is because publicly-traded companies are required by law to publish their financials and other company information.  

The world is very different when investing in private companies.  Absent an agreement, private companies have very few requirements to provide investors with information on the company’s business and finances.  That’s where information rights come in.
 
This post explores information rights typically obtained by preferred stockholders in private companies.

​Here’s a scenario inspired by real events that I have experienced:  a startup telecom company was all the rage and the company’s Series A preferred stock financing was heavily oversubscribed.  As a result, the deal was “take it or leave it” for investors and the Series A preferred stockholders invested without obtaining many of the normal provisions protecting their investment.  The company raised significantly more money than they needed at that stage.  With all this cash burning a hole in the company’s pocket, the company decided to buy some land and build itself a new headquarters building.  The company also gave management huge raises and bonuses and lavishly spent on marketing (sponsoring a race car and hiring a celebrity spokesperson), office décor, company retreats and parties.  Not surprisingly, the company blew through all of its cash very rapidly, with little progress to show for it.  The company then tried to raise another round of financing but couldn’t agree with investors on valuation (the investors wanted a very low valuation) and the company went out of business.
 
Moral of the story: If the investors in the financing described above had obtained protective provisions, this financial debacle may not have occurred.
 
This blog post is about protective provisions.

​Boards of directors for early-stage companies are very important and serve a number of critical functions.  The board hires the company’s CEO and other senior management (and sometimes fires them), and decides other major events for the company, such as whether and when to raise additional capital, enter into important contracts, sell the company, go public or to wind the company down.  In addition, the board often has committees, including an audit committee (to review the financials of the company) and a compensation committee (to establish officer compensation) that meet separately from the board.
 
Members of the board of directors are elected by the stockholders, and represent the stockholders’ interests.  In preferred stock financings, the lead investor will usually obtain the right to appoint a director to the board.  If the lead investor doesn’t obtain a board appointment right, then the investor may obtain the right to be a “board observer.”  Board observer rights are sometimes granted in addition to board appointment rights.
 
This blog discusses an investor’s rights to appoint a member of the board and/or a board observer.

​Redemption rights are rights held by preferred stockholders to require a company to repurchase its stock from the preferred stockholders.  Redemption rights are sometimes referred to “put rights,” meaning the preferred stock investors have the right to “put” its shares to the company.  A “put” in finance is the right to sell a security (usually stock) to another party at a certain price.
 
Redemption rights are rare in early-stage venture capital financings, but can sometimes be found in later stage financings, down rounds or in restructurings.
 
Let’s get started.

​In a convertible preferred stock financing, one of the most heavily negotiated terms is the liquidation preference. 
 
A liquidation preference is a priority payment right given to preferred stockholders when a company has a “liquidation” event – which means a sale of the company or the bankruptcy/winding down of the company.  In the event of a liquidation, the liquidation preference determines how the liquidation proceeds are prioritized and paid to the preferred stockholders and the common stockholders.  These payments are called a “liquidation waterfall.”
 
Liquidation preferences can be pretty complex, so let’s break this down into components.

A “dividend” is the payment of "excess cash" by a company to its shareholders (it’s a bit more complicated than that, but we’ll get to that later).  If the company pays dividends, the stockholders will receive the dividends based on their ownership in the company.
 
For privately-held companies, especially early-stage companies, dividends are generally not paid as these companies generally don’t have excess cash, and even if they did, they would use any excess cash to grow the company’s business.  But even though dividends are generally not paid by privately-held companies, it is important to understand how dividends work because preferred stock investors may negotiate dividend provisions that could result in substantial sums of money being paid to the preferred stockholders in certain situations.

​ 
When private companies hold financing rounds with venture capital and other professional investors, these investors acquire convertible preferred stock from the company.  The “convertible” or “conversion” feature of the preferred stock is fundamental to many of the rights, privileges and preferences granted to the preferred stock investors.
 
So what is the convertible feature of convertible preferred stock?  Read on.

​Anti-dilution provisions protect existing stockholders from value dilution and/or ownership dilution. They are powerful investor protections and they come in different flavors.  
 
In a prior post, we discussed Rights of First Offer (also known as Pre-Emptive Rights) which offer protection against ownership dilution.
 
This post will explore anti-dilution protections that protect against value dilution.

​A “right of first offer,” also known as a “pre-emptive right,” provides an investor in a company with the right to participate in future financing rounds so that the investor can maintain its ownership percentage in the company.  Rights of first offers are referred to in shorthand as ROFOs.
 
There are many elements to ROFOs.  Let’s break them down.

This is second part of the post on dilution.  The first post discussed ownership dilution, also known as equity dilution.  The first post can be found here:  http://www.allenlatta.com/allens-blog/dilution-part-one-understanding-ownership-dilution
 
As discussed in part one, I view dilution as having two components: ownership (equity) dilution and value dilution.  These concepts are related.  Let’s now explore value dilution.