A capitalization table or Cap table is an essential technical tool for a firm’s effective management. It provides information about the company’s equity ownership, including the sort of shares that make up its equity, how they are distributed among individual shareholders, and the market value of each shareholder’s ownership.
For startups, cap tables serve as indices for executing funding rounds. Therefore, cap table management is a crucial function for growing firms, giving them actionable insights for making tactical decisions.
In this blog post, we will explore a few aspects of cap tables and how to steer clear of some common mistakes in cap table management.
The relevance of cap tables
Cap tables offer a dashboard view of the firm’s ownership structure, voting rights, and financial worth.
Some other important functions of cap tables include the following:
1.Drive decisions about funding rounds
The founders can use a regularly updated cap table as a reference to determine the extent of dilution they can afford without compromising their controlling interest in the firm. Accordingly, they can decide whether or not to pursue a funding round. While raising outside funds for business growth is reasonable, some entrepreneurs may prefer not giving up too many controlling rights.
2.Efficiently manage option pools
Creating option pools is an essential function of equity compensation planning. Once the option pool is established, a cap table can record the operational details such as pool size, vesting schedules, exercised options, vesting dates, etc. Therefore, managing option pools becomes easier with the help of cap tables.
3.Reports the value of company shares
One critical piece of information recorded in the cap table is the market capitalization of the firm. It also provides the market value of each shareholder’s equity.
4.Aid Waterfall analysis
Waterfall analysis is a financial simulation that calculates the revenues each shareholder receives from potential liquidity events. For computation, waterfall analysis uses cap table data such as equity allocation among stakeholders, liquidation preferences, and so on. Cap tables helps you understand the implications of proposed equity issues.
5.For term sheet negotiations
During term sheet negotiations, cap tables will provide potential investors with a clear picture of your company’s equity holding pattern. It will give them current and historical ownership information, which they will require to make investment decisions.
The founders, on the other hand, can use waterfall analysis to examine the potential dilutions at each funding stage.
10 fundamental errors to avoid when managing cap tables
Many key mistakes with cap tables are due to oversights in record maintenance. The following discussion will go over 10 such basic mistakes.
Cap tables become less useful when shareholder data is incomplete or out of date. Minor data capture errors, such as not entering the shareholder’s full name, or failing to update existing shareholders’ latest contact details, will significantly impact events such as mergers and acquisitions, IPOs, and so on.
2.Undocumented verbal deals
All ‘gentlemen’s agreements’ involving equity distribution of a company, no matter how small, must be appropriately recorded in the cap table without missing any details. Unrecorded transactions may later cause legal complications.
3.Multiple versions of data existing in parallel cap tables
Keeping manual cap tables across spreadsheets and departments will result in multiple versions of the same file with different data.
4.Data loss and security issues
Maintaining the cap table in localized spreadsheets presents risks related to information security and shareholder confidentiality. Too many people handling the document manually may result in the accidental erasure of relevant information.
5.Irregular and infrequent cap table updations
Cap tables constantly change throughout a company’s existence. Any event that impacts the firm’s equity structure, such as grants, employee separations, the expiration of exercise windows, and so on, should ideally be reflected in real-time in the cap table.
6.Inaccuracies in allocation due to automatic decimal round-off
Excel and google sheets automatically round off numerical data entered in their cells unless the file user overrides the rounding-off feature. Regardless of how minute they may be, rounding off errors frequently result in erroneous share allocation and wrong valuation of stocks.
7.Omission of convertible notes from cap table
Convertible notes are often excluded from cap tables as they are originally structured as debt instruments. They get converted to equities only during a round of funding that triggers the conversion. Convertible notes must be represented in the cap table to provide a clear picture of the firm’s debt and equity composition.
8.Failure to document share transfers and stock splits
The entire transfer history of equities must be tracked and recorded in cap tables. If share transfers and splits go unrecorded for an extended period, it could create litigious situations in the future.
9.Data discrepancy between cap table and legal documents
Your cap table must always be in sync with respective legal and administrative documents, be it share certificates, stock option grant letters, employee stock option plans, etc. Incorrect capture of even a simple detail, such as the date of the option grant, will have major tax implications on the equity owner.
10.Errors when switching to cap table software
Before migrating to a cap table management software, cap table managers must thoroughly cleanse and reconcile manually maintained cap table data. This will necessitate tracking and recording every paper share certificate issued to date. Any lapse increases the chance of issuing the same share twice.
A poorly managed cap table can potentially delay investor disclosures, cause issues during the due diligence phase, complicate financial evaluation, and possibly jeopardize term sheet negotiations and funding. Unreliable cap table information will also create negative tax consequences.
Automated cap tables are more efficient, accurate, and secure than manual spreadsheet-based tables. As the equity distribution becomes more complex with each subsequent funding round, it is best to migrate to cap table management software, as it simplifies equity management and minimizes the risk of errors.
trica equity is a name trusted by more than 800 companies for equity management, ESOP management, and cap table. Our multi-functional cap table program creates and manages dynamic cap tables with facilities to issue digital shares complete with e-signature and DSC. It also generates standard and custom reports for accounting and filing.
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