(Originally published on July 20th, 2017 for PowederKeg.com)
Of the nearly 250 cap tables onboarded at eShares each month, almost every single one has at least one mistake. Most have multiple. We see issues ranging from date mismatches to incorrect vesting schedules. Founders often keep their cap table in excel (or with their law firm) and view this as the source of truth for their ownership percentages. But this is far from the reality. The truth is reflected in the signed and dispersed paper documents and certificates. The cap table is simply a manually updated record book and is therefore primed for many mistakes.
From how stocks are issued to how they are managed, we believe the broader cap table process is broken. Here are the largest problems we see with the cap table process:
1. Stock certificates are issued on paper.
It’s 2017, and we have the the ability to explore Mars, yet the company who is putting people on Mars still manages their stocks in a filing cabinet. More than just an inconvenience, paper stock certificates are routinely lost, misplaced, or destroyed (did you know the DTCC lost 1.3M stock certificates during Hurricane Sandy?), leading to people losing real value.
Delaware corporate law requires companies to issue stock certificates, but most rarely do. Usually the issuer’s law firm (not the investors) will tell shareholders they are holding the stock certificates for safe-keeping, which means employees don’t even have a place to check what their company ownership looks like.
2. The legal costs are high.
It costs between $5,000 and $15,000 to clean up your cap table using a law firm. Cash hungry startups are not going to do this anymore than they must. Most early stage startups will only do it before a financing round. That leaves months and possibly years of corrections to make, certificates to find and options to be exercised.
3. Certificates track number of shares not ownership percentage.
Because stock certificates only track the number of shares, the cap table often reflects this as well. However, investors and founders are more interested in the percentage ownership, but the total number of shares is buried deep in the cap table for the founder and not visible to the investors. Founders could inadvertently dilute themselves and early investors if they don’t keep track of their percentages.
4. Convertible notes are not recorded.
Many view convertible notes as debt when in fact they should be viewed as equity. Thus, it is not standard practice to enter convertible notes into the cap table. Instead the documents are stored in a folder and forgotten until the company raises a conversion triggering equity round. At eShares, we often see notes that have been lost or forgotten by the founder misplacing them into the wrong folder.
5. Employees suffer the most.
Employees almost always get the short end of the stick when it comes to equity. At termination, former employees are only given a short amount of time to exercise their options. They typically have to call their CFO or CEO to do so, which can be uncomfortable for employees depending on how the termination occurred. An online system solves all these problems, by making it simple and straightforward for employees to exercise and for CEOs to approve exercises.
Finally, most employees are given little to no education on what their options mean or how to take advantage of them. Because of these reasons, less than 5% of employee option grants are exercised. The vast-majority are forfeited and recycled back into the company’s option pool.
eShares is working to combat these problems every day. Our platform becomes the single source of truth by combining stock transitions and cap table record keeping. We give you complete access to view and edit your cap table without going through lawyers. Our stock certificates are issued electronically and we provide employee equity 101 educational sessions for any company. We believe this is the future of private equity.♦