Recently, the news involving cap table management startup Carta has gone viral in Silicon Valley and perhaps around the world involving the alleged trading of their customers’ shares without consent.
But what is a cap table, and how does it work? Do you need a cap table for your startup? And more importantly, do you need to sign up for a cap table management software for your company? I want to cover these questions in this article, including addressing common mistakes around cap tables that may help you better in managing your company’s equity.
Cap table 101
A capitalisation table (‘cap table’ in short) is a document that records the ownership of a company. The cap table (usually prepared in an Excel or Google Sheets spreadsheet format) reveals who owns what based on the equity instruments (e.g. shares, options, etc.) and also determines the value of the company.
The cap table also includes future or indicative share allocation, such as the employee shares option plan (‘ESOP’) and ongoing shareholder activity (usually as and when you complete each new funding round).
Cap table management
This is where it may get tricky. If you’re getting started, it may be easy to start with a cap table template online and then build it out for your company, which you can find online with all the necessary information.
However, as you fundraise in the future, Excel-based cap table templates may not be able to keep up and scale together with your company’s funding growth, which may make managing things more difficult and complicated.
Consequently, cap table software may help keep track of complicated ownership to keep track of the information and all the ongoing changes. On top of other complementary features that software may offer, like conducting valuation and reporting, etc., software may have other useful features that can help highlight common errors associated with manual entry on spreadsheets. These automated calculations reduce the risk of mistakes in equity distribution, valuation, and dilution calculations.
A well-managed cap table can help you manage how much you want to dilute as and when necessary, such as when you want to offer equity to selected key members or talents that may hopefully incentivise and motivate them to stay in your startup.
Register of members and cap table
As a founder, you need to distinguish the differences between the register of members and the cap table. Register of members is a statutory form kept by the company secretary that records the legal owner of the shares (usually updated subsequent to the issuance or transfer of the new shares).
Also Read: What founders need to know about creating a cap table
In other words, while the register of members may get constantly updated by the company secretary when there is a change in the shareholding, a cap table tells you a bigger picture about the ownership. It maps out the ownership on a fully diluted basis (i.e. the total number of shares in the company that may be outstanding/issued if all possible sources of conversion (i.e. options, warrants) are exercised by the existing shareholders and other third parties).
Beware of the misaligned shareholders’ expectations, aka ‘broken’ cap table
In the VC space, the ‘broken’ cap table is the usual phrase used when founders are found to hold a disproportionately lower percentage of ownership in comparison to the startup’s current stage or traction.
If not chosen wisely, investors may also cause trouble, typically by being greedy and acquiring too much equity (in the 30 per cent to 40 per cent) early on, like a seed stage. It’ll be a ‘red flag’ to find founders not owning a majority stake in a company when they are presumed to bring the most value to the company. What will happen to the founders’ stake down the line as other future investors will want to fulfil their equity needs as well?
The scenario may indicate wrong incentives or misaligned shareholder interests. It is unlikely for anyone to stay motivated to pursue the business due to the erosion of his or her long-term incentives.
This perspective isn’t universal among all investors, but this imbalance may likely discourage financial investors like VCs from investing, rendering your startup less attractive for venture investments.
As an investor, a cap table helps understand the ‘power dynamics’ as the ownership structure will help the investor assess what their future dilution may look like, voting rights, and control dynamics to mitigate investment risks once an investor becomes a shareholder in your company.
Also Read: The power of financial models for startups: A guide for founders and VCs
Subject to the present shareholders’ agreement, fixing a cap table may be possible by internal restructuring, such as conducting a recapitalisation exercise. Existing shareholders may need to agree to flood the founders with warrants, options, or bonuses until the cap table is back on track. In practice, it may or may not work depending on how extensive the amount of fixing that needs to be done.
Learn the common terminologies
As a founder, you need to know the common terminologies such as shares, warrants, options, vesting schedule, etc. The specific terms and definitions used in a cap table may vary depending on the funding stage and the funding documents, but they generally work the same irrespective of the company’s domicile.
If you’re unsure about these terminologies, you may want to schedule a consultation with a startup lawyer to discuss more about your cap table needs. Managing a cap table can be a nightmare for first-timers and may get more complex as the company grows and takes on new investors.
The bottom line
Deciding whether to use a cap table management software for your startup would depend on several factors: the complexity of the ownership structure (like different share classes and usage of intricate equity instruments like SAFEs and convertible notes), costs, and the expectations of the present shareholders and investors.
If your startup has a straightforward ownership structure with a small number of shareholders, a simple Excel spreadsheet might suffice for basic cap table management (in fact, most securities lawyers I know use Excel spreadsheets).
At the time of writing this, it is unclear if Carta may face an exodus of its customers to other alternatives, but it would be challenging for the company to regain its confidence as a trusted service provider.
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