It is not always clear who owns startups. It is often difficult to determine who the owners of startups are without a public register. The Delaware Division of Corporations is the most relevant source of information for startups. However, you might not have all of the necessary information and it may prove difficult to find the right legal documentation.
Access to a startup’s capitalization table (also known as the cap table) is necessary in order to understand its capital structure. Cap table contains information about shareholders, including current ownership, economic and voting rights as well as future equity purchase rights. It also shows vesting schedules, purchase prices, and vesting plans. This information can be easily accessed by investors and founders to help them calculate exit payouts, evaluate equity dilution due to new hire equity grants and assess the effect of other funding rounds.
Although startups may initially collect the data via Excel spreadsheets at first, as ownership structures become more complicated, they can be more challenging to document and follow. Errors are costly. The result has been the creation of captable management software.
The way that different captable data items are organized, accounted for and managed varies between service providers. It is difficult to automatically sync data between different software platforms without a standard. This makes it hard to switch vendors and ensure everyone is on the same page.
To address the issue, an alliance of Silicon Valley lawyers and startups vendors has been formed. In a Medium post from July 27, the Open Cap Table Coalition stated its intention to “improve the interoperability, transparency, and portability of startup cap table data.” Since standardization means fewer billable hours for lawyers and less lock-in for software platforms, it may go against the short-term interest of some participants. The coalition reflects Silicon Valley’s business model. As AnnaLee Saxenian (Dean of the UC Berkeley School of Information) noted in her 1994 book “Regional Advantage,” the Valley is a place that intense rivals become partners, and informal cooperation and exchange are institutionalized.
The founding members deserve to be praised for their efforts. Inefficiencies can be eliminated, which allows for the ecosystem to grow faster. This allows all players to focus on creating value. The open cap table coalition won’t be able to reach its full potential if investors and founders don’t have access. To make the open captable truly transparent, all equity holders must have access to the data that calculates equity value, even employees of startups.
I have written on TechCrunch in the past about the abuse potential of startup equity compensation, a highly opaque and practically unregulated market. Many employees are lured into stock options by their attractiveness. They don’t know what they are or how to value them. Stories of successful IPOs portray employees as millionaires and give the impression that startups offer a quick path to financial success. However, success is the exception, not the rule, when it comes to startups, and wrong investment decisions can result in an employee going into debt. Further, it can be damaging to the startup and the ecosystem in the long term if employees’ expectations are not in line with the startup’s financial reality.
“Pretty much nothing destroys trust between shareholders and startups quicker than poor communication, especially around issues such as the status of the cap table,” wrote Aaron Solomon, head of strategy for Esquire Digital, in support of the open cap table initiative. Miscommunications around equity can have a negative impact on employee trust and leadership. Travis Kalanick has seen firsthand how messing around with employee equity can lead to disaster.
“We are going to IPO as late as humanly possible,” Kalanick said in June 2016. It will be one day before my significant other and employees come to me with pitchforks, torches and knives. “We will IPO on the same day.” Waiting for employees to get mad is dangerous. You might wake up one day later than you did the previous day. Transparency with capital and human capital providers has never been more important in these times, where it’s harder to find qualified employees than raising money.
A couple of years ago, I interviewed startup lawyers and founders in Silicon Valley to understand why they don’t share more information with employees. The fear of being sued and disagreements over the disclosure format were constant concerns. It is now possible for industry leaders to agree on a captable format. This will allow them to reach an agreement about how data should be shared among employees. The coalition could make a significant impact on the industry by setting a standard for everyone to follow.
In startups, capital/labor relations are naturally imbalanced because employees provide human capital and are not allowed to vote. This imbalance can be partially corrected by giving employee equity-holders detailed information about what they could gain in different exit situations. Startups can attract and retain talent by making information easily understandable for their employees.
Saxenian’s book about Silicon Valley’s regional advantages describes how employee stock options played a role in Silicon Valley’s transformation during the 1970s. However, as capital markets and regulations have changed, employee, entrepreneur, and investor relationships have been negatively impacted, resulting in ongoing friction over liquidity and risk allocation. Silicon Valley’s competitive advantage can be maintained by creating equity transparency. The Open Capital Table Coalition cannot be said to have a truly open community until it takes on this challenge.
Publiated at Sun 29 August 2021, 12:40:51 (+10000).