Here’s another sad story from our “fail files” although it has a happy ending. Entrepreneurs seeking outside investment may have seen references in subscription agreements (the agreements in which the investors agree to invest in the company and the company agrees to sell them shares or notes) to “being in good standing”. This means being properly incorporated under the laws of a state and being up to date with the payment of franchise fees, or whatever the state calls its annual fees. Paying annual fees to a state may not seem like a big deal, and sometimes the bill from the state gets set aside, or the company doesn’t have the funds to pay a few hundred bucks, or someone thinks someone else dealt with it.
But if you aren’t in good standing, in most states you can’t issue securities and if you say in a contract that you are in good standing when you aren’t you have committed securities fraud!
How do you find out whether your company is in good standing? Depends on the state, but in many states there is a publicly-accessible database that lists companies that were in good standing when the state last updated the database. That update may take place only once a year. So as part of the due diligence process CrowdCheck gets a current “good standing certificate” which is the only way to check that the company is in good standing at the time it wants to sell securities.
So to return to our fail files, the company in question showed up on a database as being in good standing at the end of last year, but sometime in the spring, someone at the company forgot to pay the annual fees. When CrowdCheck applied for a good standing certificate . . . oops!
The happy ending was that we sent the company off to pay its fees, its good standing status was reinstated and it went off to offer its securities. If the issue hadn’t been fixed, all the investments would have had to have been unwound — major problem.
Entrepreneurs who want to avoid this issue should make sure someone in the team is responsible for monitoring state fee notices and paying them.