According to leading industry experts, many capitalization tables or cap tables contain basic errors.
A messy cap table can cause major problems if it doesn’t accurately reflect who owns how much of a company, and what rights they have.
A cap table’s importance grows as the company matures, since certain investors may become senior to others in terms of their rights, potentially deterring future investment.
What is a Clean Cap Table?
A clean cap table shows current, accurate, and detailed information about the company’s shareholders. It should be simple to understand, and clear to read.
The simplest way to have a clean cap table is to have as few investors as possible.
What Are the Advantages of a Clean Cap Table
Maintaining a clean cap table is not just good housekeeping. It will help you make informed decisions as your company scales. It will give confidence to potential investors during funding rounds and assist in the exit process.
Simplicity and transparency
A clean table is simple, and shows financial information, ownership and control. Because it’s clear and accurate, it can be used to prepare tax filings and legal documents, helping to keep costs low.
In addition, a clean cap table streamlines decision-making, since the fewer investors you have on board, the simpler it is to get the votes you need.
Flexibility and control
The primary benefit of a clean cap table is flexibility and control. Fewer investors mean sharper, faster and more informed decision-making.
Plus, a clean cap will save you money. While software can help you manage a complex cap table, this can come at a cost – both in terms of time and cash.
And the more investors you have on your cap table, the more time your law firm will spend every time you involve them. As they usually bill by the hour, it can often drive significantly larger costs throughout your company’s lifetime.
Attractiveness to Investors
Investors prefer a clean cap table as they can see immediately who owns what. It instills confidence that you can manage your company’s equity and business affairs. Conversely, a messy cap table can become a drag on attracting investment by deterring potential investors.
How to Maintain a Clean Cap Table
Using cap table management applications
One way to create a clean cap table that’s easy to manage is to use a dedicated application. This is vastly superior to keeping paper records, particularly for juggling multiple investors with differing rights and seniority.
A dedicated app will enable you to compute different scenarios and handle issues like the ‘waterfall’ of shareholder rights in an exit scenario.
Using an SPV to group small business angels
Another organizational method is to use a Special Purpose Vehicle, or SPV. Rather than each investor appearing as a separate line, all investors are rolled up into a single entity – the SPV. Roundtable is an expert in deploying this method.
Elements to Avoid in a Cap Table
Investors with liquidation preferences
In a liquidation or an acquisition scenario, the presence of shareholders with high liquidation preferences – where certain investors have the right to a larger percentage of the cash – can kill or delay a potential investment or acquisition.
Toxic convertible notes
A particular danger of a messy cap table is the presence of convertible notes. These are problematic as they raise red flags with potential investors, particularly if the noteholder has the right to a large percentage of the company if the loan is not repaid on time or able to be repaid at all.
Super voting rights and departed founders
The presence of super voting rights for founders can be a warning on a cap table. Some very famous companies have granted super voting rights to their founders (e.g. Facebook), but not everyone’s a Zuckerberg. Plus, the presence of former founders on a cap table (dead equity) is a huge turn-off for investors as they’ll need to be bought out or redistributed ASAP.
How to Clean a Messy Cap Table
The first step in cleaning up a dirty cap table is to identify and correct any obvious errors. Your cap table needs to be restructured so it represents a single version of the truth, where ownership percentages and rights are clear and transparent.
You can use manual methods to do this, but digital methods and apps are best. This way you can run potential scenarios through the model with several clicks. You can also use SPVs to consolidate and manage investor shares as investors are pooled.
References
[1] https://astrella.com/blogs/clean-cap-table/
[2] https://foresight.is/cap-table-hygiene/
[3] https://seedlegals.com/resources/messy-cap-table/
[4] https://www.economist.com/business/2019/07/06/new-firms-help-startups-keep-track-of-their-owners
[5] https://seedlegals.com/resources/clean-cap-table/
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