A capitalization table, a.k.a. “cap table”, is simply a record of who owns which piece of your company. As your company grows, this seemingly straightforward table often becomes increasingly complex. It can be difficult to keep cap tables current for your investors who require them to be up-to-date so that they can see the current ownership at the drop of a hat.
In this article, we review seven simple steps you can take to maintain an accurate and up-to-date cap table as you grow: confirm names, check terminations, nix paper, use employee IDs and grant IDs, account for option expense, ensure current 409A valuation, and keep it simple.
The most common mistake we see in cap tables is easily preventable. Confirm the accuracy of shareholder names before listing them on your cap table and issuing them shares or option grants. It should be their full legal name. For example, “Joey Smith” does not necessarily equate to “Joseph Smith”. “Lightspeed Ventures” is not necessarily the same as “Lightspeed Ventures IX”. Also look for other shareholders with the same last name. This shareholder may already exist in your cap table with just a name variation. Duplicate records are painful to correct after the fact, but easy to avoid. Name discrepancies and duplicate records cause extensive problems at IPO or acquisition time if you have more than a handful of shareholders.
Check Terminations Regularly
If your stock plan says an employee has three months from termination to exercise, ensure you cancel unvested options immediately and vested, unexercised options after three months (not 90 days, not one year, etc.) Sometimes a severance situation changes the termination date or the post-termination exercise period. We suggest a monthly termination check and reconciliation.
Use cap table software to issue electronic certificates instead of paper. This provides ease of tracking and management, and no risk of certificate loss. Issue electronic grant agreements via your cap table software to avoid frantically searching for signed paper agreements when an employee terminates. We also recommend that you distribute required disclosures electronically. A few cap table software solutions are even FREE to use up to a certain number of investors/employees.
Use Employee and Grant IDs
Whether or not you use cap table software (please use the software!) or a spreadsheet to manage your employee equity, we suggest you use employee IDs and grant IDs. Employee IDs can be your HR/payroll ID in most systems. If your payroll system doesn’t use them, you can still assign a number to each employee. We suggest IDs so you can easily reconcile employee demographic information (including terminations) between your HR/payroll systems and your cap table. They also help prevent duplicate shareholder records in your cap table. And, if you are using a spreadsheet to track your cap table, IDs will make your migration to a system several thousand percent faster and easier. Grant IDs are generally system-generated. If you’re using a spreadsheet, we suggest adopting a simple naming convention – for example ISO-0001 for your first employee incentive stock option or RSA-0001 for a restricted stock award. Definitely also avoid leading zeroes in employee and grant IDs; they cause unmitigated havoc in systems that use CSV export formats. Why use 0001 when you can use 1001?
Using both IDs consistently will make it much easier to manage your equity and reconcile your cap table as you grow. For example, you might issue two stock option grants to Jessie Doe, and she exercises one grant. If you’re using her payroll ID plus unique grant IDs, you can ensure you’re issuing shares upon exercise to the correct person and recording the exercise to the correct grant.
Account for Option Expense
Many startups don’t realize there is an accounting expense once you begin issuing employee stock options. This can and will hold up an audit, and it can cost your company quite a lot in money and inefficient time use while the auditor waits. Calculating this expense annually should take only a few minutes. When a company has not accounted for option expense for several years, the forensic work required to value historic grants will take exponentially longer. Further, past financial statements may be restated if the impact is material, which investors and auditors may perceive negatively. Frequently cap table management software can also account for your stock compensation expense. We do not recommend accounting for this expense in a spreadsheet if you have more than a handful of options; these spreadsheets can be quite complicated, requiring multiple inputs and calculations, and are difficult to maintain to produce accurate results.
Ensure Current 409A Valuation
A 409A valuation is a formal report produced by an independent third party that determines the fair market value of a company’s common stock when you are privately held. When you give stock options to your employees, you are giving them the option to buy equity in your company in the future at a price (the “strike price”) that is determined today. Keep in mind that, in general, most companies should not issue stock options with a strike price below the current 409A value. Many of us in the industry can share at least one horror story about correcting for 409A value at an exorbitant legal and administrative cost.
Further, we recommend not allowing option exercises while a new 409A is pending. How can employees make wise investment decisions when they don’t know the current value of the stock? The value of the company could increase or decrease with the next 409A and then you may find yourself correcting exercise statements, tax forms, and more. It’s best practice just to prohibit exercises until the new 409A arrives.
Keep it Simple
Don’t issue anything so complex that you can’t explain it to an investor or shareholder within 60 seconds. We love startup founders – your creativity and drive are consistently astounding! However, we’ve seen founders attempt to create their own equity types that don’t fall into any current law or tax code – and, subsequently, don’t mean anything to the investor, shareholder, or employee. It is also difficult to use a made-up equity type to attract and retain employees — the primary driver for issuing employee equity.
In sum, the seven action steps you can take to maintain an accurate and up-to-date cap table as you grow are: confirm names, check terminations, nix paper, use IDs, account for option expense, ensure current 409A valuation, and keep it simple. These simple steps can save hours of time and bankrolls of money while reducing the risk of error, so you’re not scrambling at the last second due to an investor or auditor request. If you have any questions about cap tables or information in this article, please email: firstname.lastname@example.org.
About Equity Plan Solutions, LLC
Equity Plan Solutions (EPS) offers a variety of stock plan consulting services in three main areas: plan administration, stock plan accounting, and special projects. We offer plan administration on numerous platforms. Our goal is to streamline and simplify processes wherever possible to reduce the risk of error and improve results.