If you are a startup leader, founder, or investor, you realize the importance of a company’s capitalization table a.k.a. cap table. Most founders and entrepreneurs aim at scaling up, which can eventually prompt an initial public offering and concern these companies to shore up their cap tables.
A successful company defines its business goals early on, exhibited by a straightforward balance sheet and a simplified capitalization structure.
However, having a fragmented cap table can affect the business’s legal documents and require restructuring. This article looks at the critical mistakes that startups and companies make regarding their cap tables and reviews viable ways to avoid them.
What is Cap Table Management?
A capitalization table or cap table provides an analysis of the percentage ownership of a corporation, the dilution of equity, and the value of equity in each round of investment by founders, investors, and other owners in an organized place. It can also include additional information such as:
- Number of shares (both preferred and common)
- Stock class
- Vesting structure
Cap table management may take any form and size for startups and be managed on paper, spreadsheet, or software.
Critical Mistakes to Avoid in Cap Table Management
The importance of cap table models cannot be undermined. As highlighted in this webinar session, a cap table is a must-have for all startups and must be studied and updated frequently as the company evolves.
Some of the cap table management mistakes that companies make include:
1. Not Maintaining Shareholder Data
In the early stages of a company, the capitalization table is often retained on an offline spreadsheet and updated on an ad hoc basis by the founder, the chief financial officer, or any relevant team member. Unfortunately, this approach to cap tables can lead to human errors.
As your business expands, it will build up new investors, advisors, and employees, many of whom will be added to your shareholder list, and entering their data like contact details, share certificates, and transaction dates manually on spreadsheets is unwise.
You can easily avoid this by opting for cap table management software which can handle all your equity details in one place.
2. Errors in Waterfall and Liquidity Calculations
With the growth of a startup, the percentage of ownership starts taking shape and may end up being converted (partially or fully) to actual proceeds at a liquidity event like a secondary sale, buyback and eventually an IPO.
This can be cumbersome since shareholders have different pay-outs, involving regular updating of the cap table to include additions, deletions, or adjustments to investor and employee shares.
Some companies also conduct waterfall analysis to determine the distribution from necessary proceedings and how that affects percentage ownership.
Setting aside time and establishing a baseline for handling waterfall analysis in your cap table can benefit companies to build on existing models and add new ones.
Neglecting the high-level organization and delaying the formatting of the cap table can have negative ramifications on managing its contents, such as:
- Missing or incorrect shareholders
- Errors in the contact information
- Incorrect share allocations
A cap table management software automates the process of subdivisions across all equity and liquidity calculations, saving time and resources.
3. Failure to Adequately Analyze Impact of Funding Rounds
Ensure the impact of funding rounds on shares is reflected in the cap table, including participation rights and caps and liquidation preference.
Fragmented cap table models can make it challenging to illustrate transactions like additional financing rounds, exit sales, secondary sales, etc.
Using the right tools with a designated dashboard can help understand the potential dilution and its effects on shareholders’ ownership stake from the lens of your cap table.
4. Failure to Delegate Ownership of Cap Table
A cap table maintains all the legal documents, records, and agreements in the business life cycle.
As a founder, you need to ensure a legal team or outside counsel maintains all the records, otherwise leading to expensive mistakes.
You can make accurate business decisions, minimize errors, and translate complex legal records into simplified numbers and formulas by relying on counsel.
trica equity is an equity management solution that digitizes your cap table as your business grows, with features that support custom equity management, valuation certificates, and multi-factor authentication. Want to discuss more? Let us know!