Do Not Screw Up Your Cap Table
We see it all the time: founders start their company and hand out equity early and often in hopes of growing as much as they can, as quickly as they can. They’ll give out equity to contractors, to advisors and to employees without really understanding what it is they’re giving. So we’re here to say: STOP. Until you know what it is you’re handing out and what it could mean or be worth in five years, just pay your contractors, and your advisors and leave equity to your co-founders, key hires and investors. We’re diving in to the most common errors we see in our client’s cap tables. If you think you’ve made similar mistakes, or are about to issue stock, reach out, we have seen it all and can help!
Only Issue Equity to Your Dream Team. Especially when you’re very new, it can be tempting to offer equity instead of payment for services. Don’t issue a bunch of shares to consultants who won’t be with you for the long haul. And even for employees, you’re going to make it harder on yourself in the long run if you offer them shares instead because the team it takes today to get it going might not be the team that can grow and scale your startup. We get it. Sometimes equity is all you’ve got. Remember it’s not free. Every option or restricted stock share you issue is a slice of your company that has value. It’s expensed like compensation, and income to those who earn it.
Don't Over Allocate your Option Pool. It seems simple enough, but you would not believe how often we see this. Companies issue more shares than they have. Couple of key things to consider: a) FIRST you need a shareholder approved option plan that allows the board to issue options (or other equity awards) to employees, directors and advisors, b) next you can issue awards according to that plan, but c) it’s like a bank account -- when you’re out of shares available to issue, you can’t keep offering them. It’s just math. Oh, and make sure you get a 409A valuation before you issue any options.
Remember: Warrants aren't the same thing as stock options. Sigh. Sadly, we’ve seen this more than once. Warrants aren’t stock options. Stock options are compensatory awards that you provide to employees, directors, consultants and advisors in exchange for services they provide you. Warrants are typically issued to investors to “sweeten the deal”. You can’t avoid all the rules tied to stock options by calling them warrants. And don’t forget to list the warrants you have issued on your cap table!
Make Sure Your Cap Table Agrees to your Financials. This is a big one, and one of the first things we look at when we take on a new client. Have you recorded all of the investment capital you’ve received in the equity section (if it’s an equity round) on your balance sheet? It’s not income. If it’s a cash investment you received for stock, have you split the entry between common stock and APIC? If it’s an LLC, is the equity recorded correctly? Remember that every share of stock or membership interest needs to recorded and needs to tie the cash you received to the balance sheet to the cap table. Sorry, more math.
Sell Shares at the Same Price in the Same Round. If you “sell” shares during a round, you need to make sure you’re selling them at the same price. Going back and re-assessing the value in retrospect is a tough and often confusing thing to do. Your lead investor usually sets the price in the round (even if you know your company is worth kabillions), and anyone else who comes in the round pays that same price (even if your mom is willing to buy shares for a dollar).
Keep the Number of People on Your Cap Table Small. Many small businesses and startups raise capital in small increments, which can lead to them needing to raise many times from many sources. This can make their cap tables complicated with too many parties involved. If you know you’re going to raise capital, try to create relationships with VCs or small funds that you can go back to when you hit milestones to keep the cap table small.
The bottom line is this: it’s much easier to do it right the first time than it is to fix it later. Usually you’ll realize you’ve made mistakes when you’re trying to close a deal and that’s not the moment you want to find out it’s a complete mess. Working with a pro (like our team) can save you headaches now AND later. Set up a free 30 minute consultation with us and we’ll help you get started!