In the start-up world, ownership in the company is one of the most important things. And a cap table is the bible that people swear by. Most investing decisions are taken based on shareholding on a fully diluted basis (FDB); hence it is important that we get this number right. One could end up having an inaccurate cap table on FDB due to several reasons – conversion ratios incorrectly applied, errors in tracking ESOPs, an anti-dilution event, and so on. Let’s discuss these in more detail
- Errors on converting a convertible instrument to equity: When convertible instruments are issued and the conversion ratios vary depending on certain events, it is easy to make mistakes. One could end up using an incorrect conversion ratio or miss out a trigger event that needs a recalculation.
- Version issues with Excel: Using Excel spreadsheets can cause version control issues, resulting in high risk of errors. Also, when complexity sets in, it is hard to keep a manual track.
- Misinterpretation of clauses: Reading through legal language in agreements is not everyone’s cup of tea. There could be misinterpretation of clauses due to lack of familiarity with legal jargon, resulting in inaccurate cap table.
- Missing audit trail for employee plans: If ESOPs are granted, it is extremely important to track each employee plan independently and make sure that the entire trail of vesting and exercising is maintained. Any error in mixing up the plans can result in significant tax issues.
- Errors on exit of an employee: If employees exit the organization, the unvested ESOPs need to be expired and the cap table has to be updated. If this is not done, the company may end up paying an ex-employee more than what he is eligible for and also show an incorrect shareholding percentage.
- Lack of control on vesting schedule: Unless you have a robust vesting schedule across plans and a strong mechanism to track options that can be exercised, employees may exercise more options that what’s due to them.
To summarise, to avoid any cap table related issues, make sure you understand every instrument type and the attached covenants clearly; you have a systematic way to track your employee rewards; and a process in place to keep your cap table updated. It makes sense to seek professional help or use software applications to have a clean and accurate cap table right from the outset.