Restructuring a Cap Table

If you’re operating a large company with numerous shareholders, you probably already know how complicated a cap table can be. This can be especially true for companies with multiple seed rounds or complex employee stock option plans. And if things start getting out of hand, it’s high time to think about cap table restructuring.

These complex cap tables can have many different types of share classes, such as ordinary shares, preferred shares, deferred shares, and many others. Along with that, there are debt instruments and employee incentives (options) that add more complexity to the cap table. These different variables can lead to unforeseen problems when recording data and other cap table mistakes.

In this article, you will learn about the troubles that arise from mishandling your company ownership records and the reasons for restructuring your cap table. You will also learn ways to create a much more simplified cap table. Let us dive into restructuring your cap table and avoiding future cap table mistakes.

Why You should Restructure Your Cap Table?

A complicated cap table structure is not only difficult to manage and understand; it also can cause dilution of the ownership of not only the shareholders, but also the founders due to missteps. Oftentimes, the company founders, employees and even management find themselves only holding common shares of the company, losing out to the rights of preference shareholders in cases of a company’s exit. This disadvantage leaves little room for mistakes among the common shareholders.

A buyout of the company is a huge event, and every minute detail matters when dividing up the company among the shareholders. That is why dilution plays such a huge role, with many shareholders getting the short end of the stick. So it’s important to avoid any potential cap table mistakes and the role of share dilution when new shareholders come into the picture.

Not only this, but each share class could potentially have their own rights, making it harder to track their value, especially for preferred share classes. These shares often have complicated liquidation rights, protecting themselves and their investments. This is why you need to avoid such cap table mistakes and think about restructuring your cap table.

Importance of having a simpler cap table structure

When people hear the word “cap table”, they assume that it is a simple spreadsheet that shows all the shareholders and the number of shares they hold. While this may be true with basic one or two member companies, the cap table gets much more crowded with the addition of share options, preferred shares and convertible notes, to name a few.

If you want to learn how to create a simpler cap table with cap table restructuring, you will have to know everything about the transactions that take place. And the best way to do this is by using the available online software to help you in getting it right from the get go. That is why Eqvista was built. Our advanced share management software will be our best tool for organizing your cap table.

What is a cap table made of?

As mentioned previously, the cap table isn’t just for recording shares, it also contains other information like security-related documents, important equity documents and the share transactions of the company. It then takes this data, and makes an easy to read table for the owners. For more complicated share ownership, this cap table can include option and warrant grants, employee stock ownership plans (ESOPs), convertible notes, and other compliance and tax and security information including Section 701, ISO $100k limit, ASC 718, 409A, etc.

Oftentimes founders make the mistake of not connecting all the share ownership of the company with the relevant documents. This can spell disaster, as potential investors will use this cap table to decide the terms of their investment into the company. They may also wish to refer to the original share documents and any agreements the company has with its owners. This is why it’s important to continually update the company data, and undergo a cap table restructuring if need be.

These share listings will be especially crucial in case of an exit for the firm. That is why with Eqvista, you will be able to accurately update your cap table in real time. This will help you stay ahead by easily allowing you to manage all your company shares, and avoid any unnecessary cap table mistakes.

Why Use a Cap Table Application for your Cap Table Restructuring?

If you are using a spreadsheet, there are a few issues you may run into. Here are a few reasons why it’s better to restructure your cap table on an application instead of using a spreadsheet:

• Difficult to track vesting schedules through a spreadsheet. And when the company issues a new vesting plan or updates an existing one, the details need to be updated regularly in order to record all the information accurately.
• The sheets can become out of date from the share grants.
• When an employee is terminated, it is not easy to handle all the details in a spreadsheet.
• All the secondary transactions need careful tracking and modeling, which can be prone to mistakes when done on a spreadsheet.
• You will not be able to easily perform any analysis of financing options. If done manually, this will require more time to understand each calculation.

It is normal for startups to encounter problems around evaluating financing alternatives, converting debt to equity, exercising options, issuing shares, vesting, and others. And if you decide to use Excel, you will have to work on complicated formulas to make this work. Plus, things can become highly disorganized later, causing headaches when tracking past share transactions.

In addition to this, the application will also help you in making smart decisions around funding, hiring and everything else related to equity. For these reasons, many business owners are making the switch from traditional spreadsheet records to online cap table management systems.

Common Reasons for Cap Table Restructuring

To effectively restructure a cap table, companies typically need to negotiate with existing shareholders, potentially buy back shares, create new share classes, or even perform a complete recapitalization. 

There are several important reasons why a company might need to restructure its cap table:

• Misaligned ownership structure: If founders or early employees have departed but still own large equity stakes, it can demotivate current team members and deter new investors. Restructuring allows for rebalancing equity to better align with current contributions.
• Excessive dilution: If too much of the company (over 50-60%) has been sold to early investors, it leaves little room for future funding rounds and can scare away new investors. Restructuring can help reset ownership percentages.
• Overly complex structure: Cap tables with many different share classes, complicated rights, or numerous small investors can become difficult to manage and understand. Simplifying the structure makes it easier to track ownership and rights.
• Decision-making challenges: A fragmented cap table with many small investors or special veto rights can slow down important decisions. Restructuring can streamline voting processes.
• Unattractive to new investors: Messy or imbalanced cap tables can deter venture capital firms from investing. Cleaning up the structure makes the company more appealing for future funding.
• Preparing for growth: As startups scale, they often need a cleaner cap table structure to support future financing rounds, employee stock options, and potential exits.
• Fixing past mistakes: Early-stage companies sometimes make cap table errors due to inexperience. Restructuring provides an opportunity to correct these issues before they become more problematic.
• Aligning with company goals: Restructuring allows for better alignment between equity ownership and the company’s current trajectory and plans.

It’s crucial to involve legal and tax advisors in this process to navigate the complexities and ensure compliance with regulations.

Possible Cap Tables Mistakes Startups Make

Each cap table mistake stems from two main sources: having multiple cap table versions and a lack of institutional control. These issues usually come only when you are determined to use a spreadsheet for creating your cap table. In fact, there are many benefits of keeping better track of your cap table. You can check out our guides to learn more about it!

For those learning ways to avoid potential errors, here are the most common cap table mistakes that startups come across and should be avoided:

1. Founders Not Comprehending Liquidation Preferences

This is one of the biggest cap table mistakes that any founder can make. The complexity of liquidation preferences can be hard to capture using a spreadsheet. It can also have potential negative effects on the dilution of the existing shareholders, especially upon exit of the company.

As the main role of a cap table is that founders are able to control dilution, with a spreadsheet, it becomes difficult to follow this. But with a better share management system, you are constantly updated about the current ownership and notifications if anything goes wrong.

2. Not Accounting the Option Expense when Updating the Cap Table

A lot of founders often overlook the expense for their option grants. This expense is recorded in the balance sheet of the company. It is important to carefully consider the expense implications of the new share options as well as altering the old awards. You will need to follow the guidelines as per the ASC 718 to stay compliant with the relevant rules for option expensing.

3. Issuing Options without a Defensible Fair Market Value (409A)

If you own a company and issue shares to your employees, you might know that the 409A valuation is very important for the share price. It sets the fair market value of your company’s shares. This is for the company to grant new shares, and to accurately record the value of these for tax purposes. However, some founders make the mistake of granting their shares without getting a proper 409a valuation.

Some companies are unable to get safe harbour for their 409a valuation as they do this valuation on their own. This can cause risk for the company and leave potential areas for an audit by the IRS. You may end up having to pay a large amount of tax and put your employees at further risk. This is why your cap table can also act as a place for recording this information to stay compliant with the rules of each 409a valuation.

4. Forgetting the Form 3921 & Rule 701

For those with larger corporations, you might pass the Rule 701 threshold. In order to avoid any cap table mistakes, you should be well versed about the Rule 701 and all its requirements.

As a matter of fact, there are a lot of companies that do not know about this requirement and cross the threshold. Once this happens, they are notified by the IRS, which may result in potential penalties. Form 3921 is used for reporting the ISO option grant exercises and needs to be filed every year when these exercises occur.

5. When Moving from a Spreadsheet to a Cap Table Management Software, Forgetting to Track the Last Granted Paper Certificates

Some founders tend to forget that they need to track the paper certificates. And because of this mistake, they tend to issue the same stock again. Hence, using a cap table application can be a better solution. All of the past transactions can be seen in the company’s timeline.

After reading these, it’s high time you consider using a reliable share management app and avoid these cap table mistakes. You can also save time for recording your data, rather than creating new templates and filing paper certificates for your shares. You will be on the right path towards the future success of your company.

Example for Restructuring a Cap Table

Let us consider a company Corp Innovations, a sophisticated software company, specializing in cutting-edge AI technologies.

The company has two founders (with 3.2 million shares) who have issued:

• The type of security – common shares, preferred shares, options, and warrants to shareholders.
• The role of shareholders in the company – Founder, Advisor, Investor, and Employee. 
• 3.6 million common shares to its shareholders at $0.0001 price per share.
• 700,000 preferred shares to its shareholders at $0.25 price per share.
• 60,000 stock options to its shareholders and has authorized 40,000 stock options to be granted in the future.
• 25,000 warrants have been issued to its shareholders.
• In total, 4.4 million shares have been issued to its shareholders.

Here’s the cap table of the company before restructuring, summarizing the ownership structure and capital committed.

The company restructures the cap table involving the following changes:

• The founder’s shares have been listed separately under the column “Founders”.
• The preferred shares have been categorized based on the funding round – Seed and Series A. 

The cap table of the company after restructuring along with the following changes made:

• The founders own 3.2 million shares in the company.
• 465,000 common shares to its shareholders at $0.0001 price per share.
• 210,000 Seed – preferred shares to its shareholders at $0.25 price per share.
• 490,000 Series A – preferred shares to its shareholders at $0.25 price per share.

Benefits of Restructuring a Cap Table

Restructuring a cap table can provide several important benefits for startups:

• Better alignment of interests: Restructuring can help realign equity ownership to ensure founders, employees, and investors have appropriate stakes that motivate them and reflect their contributions.
• Improved attractiveness to investors: A well-structured cap table makes the company more appealing to potential investors by clearly showing ownership stakes and avoiding overly complex arrangements.
• Simplified management: A streamlined cap table is easier to maintain, update, and understand than a complex structure with multiple share classes.
• Enhanced transparency: A clear, restructured cap table provides better visibility into ownership and makes it easier to model exit scenarios and valuations.
• Improved governance: Consolidating share classes and updating shareholder agreements can lead to more efficient decision-making processes and board structures.
• Correction of past mistakes: Restructuring allows companies to address issues like selling too much equity early on or having departed co-founders with large stakes.
• Preparation for future funding: A clean cap table positions the company well for upcoming funding rounds by removing potential obstacles like anti-dilution rights or unfavorable voting structures.
• Fairness and motivation: Restructuring can ensure that key employees and founders have meaningful equity stakes, which helps with retention and motivation.
• Compliance and legal clarity: A properly restructured cap table helps ensure compliance with securities laws and reduces the risk of legal complications.
• Facilitation of exits: A simpler ownership structure makes the company more attractive to potential acquirers and can streamline the process of going public.

When restructuring a cap table, it’s important to use specialized software like Eqvista ,rather than spreadsheets to ensure accuracy, ease of updates, and proper tracking of complex elements like vesting schedules and secondary transactions. The process should be approached carefully, considering the interests of all stakeholders and potential tax implications.

Advantages of Using Cap Table Management Software

From what we have mentioned already, you can see that while working on the cap table restructuring, it is better to use a cap table software and not a simple spreadsheet. To help you understand better about why you need to use a cap table management software, here are some reasons you should know:

• Credibility: Let us say that an employee you are about to offer shares to or an investor you are about to make a deal with asks for the company’s capitalization table. In this case, it is much better to share a link to the cap table or invite them with an email to view it, instead of sharing something from your spreadsheet.
• Effort: If your company is small, having a spreadsheet is alright. But what happens when you add investors and the company grows? In this case, you will have to put in a lot of time and effort to take care of your cap table spreadsheet. And as the saying goes, time is money.
• Accessibility: An online cap table can be accessed easily by many people at one time. With a spreadsheet cap table, it can be hard to manage and access this. So for sharing information and keeping everyone up-to-date, it’s better to track your shares on a cap table designed for this.
• Accuracy: Updating a spreadsheet can be very hectic. In fact, unless you have your accountant or lawyer by your side, you cannot be completely sure there are no mistakes. For cap tables with more complicated share structures, both calculations and the law will play a significant role.
  Hence, using a cap table application is much more helpful. You can share the details of the updated cap table, and have the professional review this for accuracy. This can ensure that all the information is correct, without having to go back and forth with your information.
• Complexity: Do your stock agreements have fractional shares or interest on convertible notes? Does your company issue many employee stock options with vesting schedules?
  For these more complex share transactions within a company, recording and accurately portraying this can be extremely difficult on a spreadsheet. Problems occur not only for the initial recording, but also for constantly updating this, and making sure it’s all correct. But with an application, these calculations will be done automatically.

With this in mind, the Eqvista app incorporates all the advantages of an online cap table for companies looking to manage their shares. If you are still using a traditional excel sheet, you can consider to having a cap table restructuring, and move everything online. We have also incorporated advanced waterfall and round modeling financial models that can help you better with your company’s financial decisions.

How can Eqvista help?

Eqvista is at the top of the game when it comes to the best cap table software. We strive to combine an advanced cap table tool with an easy to use interface and accessible software for all your shareholders. In fact, users can edit and work on their cap table restructuring easily using Eqvista.

For all the convertible notes and the vesting schedules, all you need to do is create the plan and the app takes care of the rest. It will also help keep these records to stay compliant with the law. In short, it is the best app you can have by your side to avoid any cap table mistakes.