Best Way to Prepare For an Exit? Get Your Cap Table Right From The Start!

A few weeks ago, I was brainstorming with Jason Mann, the NASPP’s Director of Content, over ways to adapt Stock Plan Education for different personas. We touched heavily on how to approach different topics by acknowledging each personas level of understanding and subject of interest, but then Jason brought up THE QUESTION that all founders want to know, which is essentially the equity administration equivalent of “Who is Taylor Swift’s new song about?”: 

"How do I prepare for an IPO or acquisition?"

There are several important things to consider like compensation policy, stakeholder communication, dilution, and planning reserves, but experience has taught me better. On the Equity Frontier, one simply cannot move on before settling one’s scores, so if you plan to have a successful exit, you need to get everything right from the start!

However, this most often isn’t the case because an in-house Stock Plan administrator is not cheap and due to the reduced plan activity of early-stage companies, hiring one usually isn’t seen as the most cost effective solution. So how are these early-stage companies managing their Cap Tables? Well, most often they’ll hire a law firm or grab whoever says “not it” last within their company and trust one of the most crucial aspects of any startup, to someone who may or may not know the ins and outs of equity administration. 

Why this is a problem: My experience

In December 2022, I was asked to do a Cap Table cleanup for a Series A company whose Cap Table was outdated and had been poorly managed. They wanted us to audit their Cap Table and it was the hardest and most uncomfortable thing I had done to date.

Besides all the missing documents, I was certain their SAFEs were supposed to convert post-money while their round was calculated pre-money, but who was more likely to be wrong? To me, it was inconceivable that things would be this poorly managed, especially at this stage.

So, I read all I could from several sources again and again and again before finally submitting my report in the humblest email I could possibly muster and the entire time, I felt like a student turning in an exam that they were certain to have failed. But in the end, I was correct, and that was my first insight into how dangerous improper Cap Table management could become.

The Aftermath

The company in a panic wanted to know the estimated impact as soon as possible and it was discovered, that this oversight actually led to an aggregate decrease in stock value for preferred shareholders up to $30,000, while convertible holders actually saw an increase in value as large as $60,000.

More than a year was necessary to finish gathering the missing information. They presented their plan of action to be reviewed so documents and communications could be drafted and delivered to shareholders as necessary. They needed all this time to find emails, offer letters, and any document that could provide support for all the grants, terminations, exercises, and accelerations to confirm whether or not they were either wrong or poorly documented on their Cap Table.

Poor Cap Table management can lead to significant financial consequences and time-consuming cleanup efforts. Accurate record-keeping and regular maintenance are essential to avoid these pitfalls and this is why I can’t stress enough the importance of getting things right from the start.

What to get right from the start

Let’s think of a SaaS company, it doesn’t matter at what point you are in your company’s lifecycle, you need to consistently do the following:

• Understand your clients' needs
• Build the solution
• Make it usable by the end user

As your company scales, you will need different teams who specialize on each part of this process who often times do not know the intricacies and roles of every other team within the organization and for this reason, companies often hire a product manager.

The person managing your Cap Table may not be familiar with all the legal and financial reporting requirements. Your HR team might not know how to track tax mobility for equity, and the person designing your awards may not be aware of the administrative burden their provisions cause. Without timely information flowing between teams, your plan may not be prepared for rapid growth.

Just as your product or service needs a product manager to communicate with clients, developers, designers, and support, you too need a plan administrator who understands the financial, legal, and HR aspects of your equity plan to keep it running smoothly.

Plans that scale without proper administration often have a few things in common, which, if carefully considered early on, can help you avoid a lot of trouble and financial heartache:

Lack of well-established processes:

• Delayed transactions – Exercises, terminations, and transfers reflected over A YEAR after the effective date can cause over-exercising, tax violations, and several other issues.
• Use of incompatible grant agreement templates - Especially common with Vesting schedules, using templates indiscriminately can lead to vesting schedules different to what was approved by the Board.
• Information sharing – Does your Cap table owner know how a clerical error can affect financial reporting, payroll, or even legal?

Lack of Consistency:

• Name consistency – You hired John Galt, and recorded that on your HRIS, the Board approved the award for Jack Galt, whereas the Cap Table displays Johnny G, the perfect situation to create violations related to the 10% shareholder or 100K rule.
• Database incompleteness – If you decide certain information can be found on your Cap Table Management software, make sure it’s always included. Bad data is the main cause for issues with disclosures and reports.

Lack of foresight:

• Vesting on the same day as the hire date – Congratulations! Your company has grown and now you have a thousand participating employees and daily releases to process.
• Monthly vesting on the first/last day of the month – If your RSUs vest every month, they will vest in December and January when several teams are swamped with year-end activities, and you might not want to add to that.

Excess of creativity

• Individual Vesting Schedules – Offering provisions that accommodate each participant may initially sound like a good idea, but it can and eventually will create a lot of misunderstandings, especially with a lean administration team.
• Hourly Vesting schedule – Do you have someone who can immediately update vesting schedules each time a consultant clocks in? (This is becoming way too common and needs to stop)

Conclusion

In summary, having a dedicated equity plan Administrator who understands the complexities of equity compensation and can coordinate between various teams is crucial for avoiding costly mistakes and ensuring smooth operations as your company grows. By establishing well-defined processes, maintaining consistency, planning for the future, and keeping things simple, you can set yourself up for success from the start.

Solution Showcase: Cap Tables

Managing a cap table is hard enough as it is and there is no reason to make things more difficult than they already are. Too many founders still live in spreadsheets and other inefficient means of tracking ownership within a company. 

For this reason the NASPP has put together a free showcase of the 12 best in class cap table providers to help you find the perfect solution for your startups current needs!

Check it out here  ------->  Solution Showcase: Cap Table

Day 1 Presenters:       

• JP Morgan
• Carta
• Cake
• Qapita
• Eqvista
• Pulley

Day 2 Presenters: 

• Mantle
• Morgan Stanley
• insightsoftware
• Fidelity Private Shares
• AngelList
• OptionTrax