In 2024, over 30 million businesses will need to meet new compliance requirements. The Corporate Transparency Act (CTA) takes effect on January 1st and mandates U.S. companies to file Beneficial Ownership Information (BOI) reports with FinCEN.
All types of businesses will be impacted by the CTA. However, startups may find BOI reporting requirements especially challenging. The threat of severe civil and criminal penalties for noncompliance means that startups must prioritize BOI reporting to successfully launch their business.
In this article, we’ll break down how the Corporate Transparency Act and BOI reporting specifically affect startups. Additionally, we offer recommendations for early-stage companies to ensure full compliance.
What is a Startup Company?
People commonly use the term “startup” to describe companies aiming to quickly establish and grow. Rapidly growing startup companies often receive funding directly from private investors, like Venture Capital firms, Private Equity funds, or individual Angel Investors.
Do Startups Need to Comply With the CTA?
Most startups are incorporated as Delaware C-Corporations. This means that these companies are subject to the CTA and must file Beneficial Ownership Information (BOI) reports in 2024. BOI reports are directly submitted to the Financial Crimes Enforcement Network, or “FinCEN”, an arm of the U.S. Department of Treasury.
What are the Penalties for CTA Noncompliance?
Companies can incur civil penalties for CTA violations, including fines of up to $500 per day. Willful noncompliance with the reporting requirements can result in a criminal penalty, carrying a fine of up to $10,000 and a prison sentence of up to two years. Authorities can target a company’s senior officers or any beneficial owners who neglect the BOI reporting responsibilities.
How Do Startups Comply With the CTA?
To comply with the CTA, startups must file Beneficial Ownership Information reports directly with FinCEN. These BOI reports detail the significant owners and important decision-makers within the company. Specifically, reporting companies must disclose any individual who owns at least 25% of the company’s ownership interest. FinCEN identifies these individuals as “beneficial owners”.
Individuals listed in a company’s BOI report must provide specific information, including:
- Their full legal name
- Date of birth
- Current residential address
- An image of a valid ID document
The BOI report also contains details about the reporting company, such as:
- Full company legal name
- State of Incorporation
- Date of Incorporation
- The principal business address
- The federal tax ID number
- Any and all trade names or DBAs
Besides beneficial owners, the BOI report also needs to list all control parties. A control party is an individual with “substantial control” over the reporting company, meaning they significantly influence major company decisions.
Companies established after January 1, 2024, must include a third group in their BOI reports: the company applicants. These individuals play a central role in forming the business entity.
But merely filing an initial BOI report doesn’t ensure compliance with the CTA. The officers of a reporting company must consistently update the company’s Beneficial Ownership Information. Reporting companies must send BOI Updated reports to FinCEN within 30 days of any change in BOI data
Who are the Beneficial Owners, Control Parties, and Company Applicants in a Startup?
In a corporation, beneficial owners often mean the company’s shareholders. However, a person with indirect ownership in a reporting company might also qualify as a beneficial owner. For example, employees with stock options or a type of convertible interest in a reporting company can become beneficial owners if their shares reach the 25% threshold.
Control parties in a corporation usually comprise the company’s senior officers, executives, and the board of directors. However, a person might qualify as a control party if they hold significant responsibilities in any of the following areas:
- Business Operations: Determining the nature and scope of the business and initiating new business lines
- Finances: Overseeing major expenditures, asset sales or leases, equity issuance, and senior officer compensation
- Corporate Structure: Managing company reorganization or mergers, modifying corporate documents, and appointing or removing senior officers
New companies must identify two company applicants in their reports. Typically, the first company applicant is the primary individual responsible for initiating the formation of the business entity. In a startup, this person is usually the founder who decided to incorporate the company.
The second company applicant is the person who submits the incorporation documents to the Secretary of State’s office. If a third-party incorporation service does the filing for a company, the second company applicant will be an employee or representative of that service company.
Why is BOI Reporting Challenging for Startups?
The inherent nature of startups makes BOI reporting a complex task. The CTA mandates that reporting companies continuously update their Beneficial Ownership Information with FinCEN.
This means that companies must complete BOI Updated reports whenever the initially reported information changes. For example, if a startup secures a new investor with an ownership stake greater than 25%, or if the company introduces a new CEO, they must file a BOI Update report.
Given the rapid growth that some startups experience, these companies might frequently update their BOI reports as new investors join or leadership roles shift. Also, many startups offer stock options to their early employees as incentives, which can add complexity to the company’s ownership structure.
What Defines Ownership Interest for BOI Reporting?
Commonly, beneficial owners are those with direct ownership in a reporting company, such as corporate shareholders. But beneficial ownership can also include other forms of equity.
For BOI reporting purposes, ownership interest encompasses:
- Equity, Stock, or Voting Rights: This interest might or might not come with voting rights
- Options or Privileges: Stock options and related entities like puts, calls, or other options to buy or sell equity, stock, or voting rights
- Convertible Instruments: These instruments, such as convertible equity or voting rights, count as ownership interest, irrespective of any payment needed for a conversion
- Future Arrangements: Future considerations like warrants or rights to buy or sell equity, stock, or voting rights also count
- Capital or Profit Interest: Interests in a company’s assets or profits, often seen in LLCs which might refer to these as “units”
An individual with any ownership interest in a reporting company can become a beneficial owner if that interest surpasses 25%.
How Can Startups Prepare for BOI Reporting?
Proactive measures can ensure that reporting companies file accurate and timely BOI reports.
Step #1) Understand the Requirements and Educate Stakeholders:
Startups should prioritize education and communication. By aligning all relevant stakeholders with the BOI reporting requirements, collaboration around compliance can flourish. It’s vital for everyone in the organization, not just beneficial owners, to understand the implications of the Corporate Transparency Act.
Step #2) Implement Workflows for Data Collection and Storage:
With multiple beneficial owners, startups need efficient processes for data collection. Given the sensitive nature of some required data, like ID images, secure storage becomes crucial.
Step #3) Develop Systems to Track Changes:
Frequent changes in ownership and leadership positions are common in startups. As such, they need robust systems to monitor these changes, ensuring they always maintain compliance.