Cap Table Housekeeping

Good housekeeping of a corporate capitalization (cap) table is an essential demonstration of a startup leader’s competence, yet it is full of potentially painful pitfalls when moving along the learning curve.

Fundraising is well underway. The term sheet is signed. Legal due diligence has begun. Now, any little oddities, documentation mistakes, and loose ends come to the fore. The investor’s lawyer starts asking:

• Can you please provide all the documents related to this [previous round] of funding?
  
  
• Where is the signed document that terminates that equity-compensated advisory agreement that ended before the stock grant was fully vested?
  
  
• Where is the third-party 409(a) valuation that supports the Fair Market Value of these stock option grants?
  
  
• What was the price paid for the shares of stock granted to an accelerator? Please provide all agreements related to the accelerator.
  
  
• Where are the records related to that co-founder with restricted stock who left the company?
  
  
• Please provide the duly filed certificate of incorporation that lays out the rights and privileges of the stockholders (owners) of the corporation.

What all of these questions have in common is that they touch on the cap table. Because cap tables describe the ownership breakdown of a corporation like a startup company, investors who are trading their investment for stock (equity) or something that converts into equity (like a SAFE or Convertible Note) care a great deal about what the company’s ownership looks like. It matters that all the documentation and transfer of shares is done correctly, or things can get contentious and messy when there is money to be doled out.

What is a Cap Table?

A cap table is a document, like a spreadsheet or a table, that details who has ownership in a company (most commonly, startups raising money should organize themselves as a Delaware C-Corporation as that is the standard and accepted corporate form). Every cap table should contain at least the following details: authorized shares, outstanding shares, unissued shares, shares reserved for stock options/grants, valuation details of the last priced round (pre-money valuation, amount of new equity raised, per-share price, and number of shares), and a complete list of shareholders.

A cap table lists all of a company’s securities – such as common shares and preferred shares, options, SAFEs, convertible notes, and warrants. It shows how much of each security type each investor owns and their current ownership percentage. Fundamentally, a cap table comprehensively lists everything an investor would want to know about a company’s ownership. 

Why does Cap Table Housekeeping Matter?

Ownership allocates who gets what in an exit scenario. The rights and privileges of each class of stock relative to other classes of stock determine who gets paid what, and sometimes only some of the owners will get paid if, for example, the exit isn’t big enough for everyone to have a great return. When the hoped-for time comes to divvy up who gets what, no one wants there to be any ambiguity about who owns what.

By the way, as counterintuitive as it may seem, the concern is much more on the “win” than on the “lose” side because when a startup fails and shuts down, everybody on the cap table loses together. There isn’t any “goodness” to share. The fear in the back of potential investors’ and their lawyers’ minds is that, in a “win” scenario, someone will come out of the woodwork with a claim on the startup corporation’s stock and sue to get their “share.” That is the ugly scenario that good cap table housekeeping is intended to avoid. 

Good Housekeeping Practices for Cap Tables

There are two dominant principles of cap table management for founders and startup CEOs to keep top of mind at all times:

1. Keeping accurate and well-documented ownership records is critical. Remember that when it comes to company ownership, if it isn’t properly and legally documented, you cannot prove that it happened!
   
   
   • Ensure you properly form your corporation with a filed Certificate of Incorporation and Bylaws, designated corporate officers, and other legal matters. Then, make sure you follow and update them as needed.
     
     
   • Make sure you establish a formal stock option plan with appropriate legal documents if you plan to issue stock options and/or restricted stock grants. Be sure you have the proper justification for the value you will use to issue such options/shares.
     
     
   • Ensure that any time someone with options or restricted stock compensation terminates their relationship with the company, proper legal procedures are followed to document what legally happens to those shares.
     
     
   • Ensure that all shares/options are issued on a timely basis, with appropriate authorization by the Board of Directors, any required shareholder votes, and any officer authorization.
     
     
   • Avoid relying on informal communications such as texts, emails, or verbal discussions, as those are rarely comprehensive enough to satisfy lawyers conducting due diligence. Remember that even if everything seems harmonious at the moment, if circumstances change and something goes wrong/really right and a dispute arises, you will need the protection of proper legal documents.

• Your experienced startup corporate attorney is your expert guide in all things cap table. When in doubt, if it involves fundraising, any form of stock, any form of stock options or warrants, and ownership thereof, check with your attorney on how to document the situation so you do not leave any loose ends dangling around your cap table.  

By exercising good cap table housekeeping practices, you can avoid the dreaded: “We need you to clean up this loose end before we will continue evaluating this investment or before we are willing to close.” It is also a way to showcase expertise and experience that builds investor confidence that the startup’s management team has essential corporate management skills to take good care of their investment.

Disclaimer:  Remember that I am not an attorney, nor am I giving you legal advice. Just trying to highlight some words to the wise and encourage you to consult your attorney for the right actions in your circumstances.