Cap tables and your private equity investment

Cap table management is very tricky. And when a company doesn’t take control of its cap table early on, it gets even trickier.

If you read Matt Levine’s daily Bloomberg column “Money Stuff”— and of you don’t already read it, I highly recommend it— you probably came across his recent post about the difficulties of cap table management:

Some hot startups in Silicon Valley, including some “unicorns” worth $1bn or more, have a problem: they are not sure who owns them. As fast-talking founders pitch to deep-pocketed investors, junior staff back at the co-working space maintain simple spreadsheets with investors’ names and the number and type of shares they hold. They often get things wrong. This may lead to disputes when a company lists, is acquired—or goes bust.(Matt Levine Money Stuff, July 15, 2019).

In my experience, the issue goes even deeper than the above summary. The issue of cap table complexity also involves the company’s obligations with holders of instruments representing future equity acquisitions, conversions and vesting, such as SAFEs, convertible notes and options. It also involves startups who regret certain equity compensation obligations and pretend they never happened; failed capital commitments that result in an application of some sort of clawback mechanism; and capital calls that are in the process of being performed. 

If you are an investor, it is of tremendous importance that you protect yourself by ensuring that you are provided with the proper legal instruments showing your rights as a holder of equity (or potential future equity). This also goes for recipients of inventive compensation such as ISOs and NSOs. Your securities law attorney should review the legal instrument reflecting your ownership (or future ownership), and help you with or instruct you on the safekeeping of the relevant instruments. 

To the extent the venture you’re investing in is a little more sophisticated and less “bootstrapped startup-y”, I would suggest asking about their cap table management and whether they use a cap table management service like Carta. 

It’s also important to understand whether your rights are further protected by the corresponding legal instruments. For instance, if your investment is not particularly large, you may want to consider insisting on dispute resolution in the relevant agreements by way of litigation of disputes in your local courts, as opposed to the startup’s “standard” dispute resolution clause requiring a 3 arbitrator panel sitting in San Francisco or NY. This sort of dispute mechanism could prove to be a barrier that makes it prohibitively expensive for you to ever take legal action if your equity is not properly recognized, because the cost of such an arbitration alone could far exceed your investment. Unless of course the startup becomes a “unicorn” while your legal claim is still valid … then, in that case, the 3-panel arbitration may be worthwhile after all!