What is Ownership Interest in a Reporting Company
Ownership interest is a catch-all term used by FinCEN to measure the amount of ownership or control in a “reporting company”. A reporting company is the term used by FinCEN to refer to a company that is required to report its Beneficial Ownership Information (or BOI).
Ownership interest has different forms, it can represent current ownership or future ownership, and it can be direct or indirect. We’ll explain all these and how they impact what FinCEN defines as a Beneficial Owner of a reporting company.
Types of Ownership Interest
FinCEN outlines the following types of ownership interest:
- Equity, Stock or Voting Rights. This is any interest in a reporting company classified as stock or anything similar, regardless whether it confers voting power or voting rights, and even if the interest is transferable. Examples cited by FinCEN include:
- equity, stock, or similar instrument
- preorganization certificate or subscription
- transferable share of, or voting trust certificate or certificate of deposit for, an equity security, interest in a joint venture, or certificate of interest in a business trust
- Capital or Profit Interest. This is an interest in a reporting company representing an interest in the assets or profits of a company organized as an LLC, which is similar to stock in a corporation and sometimes referred to as a “unit”.
- Convertible Instruments. This is a right or instrument convertible into equity, stock or voting rights or capital or profit interest, in a reporting company, whether or not anything needs to be paid to exercise the conversion. The related items are also ownership interests:
- any future on any convertible instrument
- any warrant or right to purchase, sell, or subscribe to a share or interest in equity, stock, or voting rights or capital or profit interest, even if such warrant or right is a debt
- Option or Privilege. An put, call, straddle, or other option or privilege of buying or selling equity, stock, or voting rights, capital or profit interest, or convertible instruments, except if the option or priviledge is created and held by others without the knowledge or involvement of the reporting company.
- Catch-All. Any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.
What’s important to understand is that an ownership interest doesn’t necessary relate to voting rights, although voting rights can have an impact on Voting Power (an important aspect of determining amount of ownership interest or control over a reporting company). Ownership interest relates to any form of interest in a company, whether transferrable or not, whether current or a possible future interest.
Current versus Future Ownership Interest
Numbers 1-2, plus possibly #5, represent current ownership interests, while numbers 3-4 and possibly #5, represent future ownership interests.
Current ownership interest represents that ownership interest currently owned, conveying upon the owner whatever rights in remuneration (i.e. dividends, profits, distributions, etc) and control (i.e. voting, influence, etc), while future ownership interest represents that ownership that could be owned at sometime in the future, if exercised or converted.
For FinCEN purposes, calculations of ownership are to “assume they have been exercised or converted in all calculations“. See Page 23 in the Small Entity Compliance Guide, December 2023 Version 1.1. This can create some confusing results. Consider two examples. First, let’s pretend there are two owners, John and Joe, who own 1,000 shares each of a company, but each has a child who holds an option that gives them 2,000 shares each when they turn 21. How much ownership interest do John and Joe own? 50% each? No, they would own 16.67% each. Why?
FinCEN says to assume options have been exercised. Therefore, in this example, we are to assume there are 6,000 shares issued (i.e. 1,000 each to John and Joe, and 2,000 each for each of the two children). 1,000 / 6,000 is 16.67%. Therefore, neither John nor Joe would cross the all-important 25% threshold for reporting purposes, although it’s very likely John and Joe will still be considered Beneficial Owners because they maintain Substantial Control over the reporting company.
Direct versus Indirect Ownership Interest
We talk more about Indirect versus Direct Ownership Interest in another blog article, but it’s important to understand the basic concepts of this. Specifically, a direct ownership interest means an individual, trust, company or other entity possesses an ownership interest in the reporting company. This is what you probably expect, when you think of “owning the reporting company.”
What percentage of a reporting company is directly owned by its owners? The answer is always going to be 100%, no matter how many shares are issued, or how many parties own the reporting company. The answer here is always — 100% of the company is directly owned by its owners.
Indirect ownership is different. Indirect ownership makes sense, when you remember that FinCEN requires Beneficial Owners to be individuals only. This means that trusts, companies and other entities (not individuals) that directly own a reporting entity cannot be Beneficial Owners themselves. Instead, the individuals who have relationships to such trusts, companies and other entities, and exert some level of control over the reporting company on behalf of such trust, company or other entity, are said to have an indirect ownership in the reporting company.
This can lead to a confusing analysis, because unlike the 100% for direct ownership, there’s no limit to the amount of indirect ownership of a reporting entity.
Consider this example: John Doe owns 50% of a reporting company, and the John Doe Trust owns the other 50%. The John Doe Trust has two co-trustees (Persons 1 and 2), and two beneficiaries (Persons 3 and 4), all of whom have authority over the trust assets. Let’s say that John Doe is Person 1. In this example, John Doe has 100% of direct and indirect ownership (50% direct, and 50% indirect from his control over the Trust, which itself has a 50% direct ownership of the reporting company). Persons 2, 3 and 4 also have a 50% indirect ownership interest in the reporting company. John Doe, and Persons 2, 3 and 4, all must report their Beneficial Ownership Information to FinCEN, and there is 200% of indirect ownership interest attributed to the reporting company (i.e. 50% each to John Doe, Person 2, 3 and 4).
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