The ownership of startups is often a mystery. In the absence of a public registry, it is difficult to figure out who owns what. Since most startups incorporate in Delaware, the Delaware Division of Corporations holds relevant information, but you may not be able to get all the information you need, and putting it together from the legal paperwork will be challenging.
To understand a startup’s capital structure, you must have access to its capitalization table, also known as cap table. The cap table shows shareholder information, current ownership stakes along with economic and voting rights, future equity purchase rights, vesting schedules and purchase prices. All of this information is compiled into a format that founders and investors can digest easily, allowing them to calculate payouts in various exit scenarios, analyze equity dilution from new hire equity grants, and understand the impact of additional funding rounds.
Initially, startups might collect this data using Excel spreadsheets, but as the ownership structure grows more complex, it becomes more difficult to follow and document, and the cost of errors become a big problem. This has led to the development of a cap table management software industry.
However, the way in which various cap table data items are organized and accounted for varies among the different service providers. Without a standard, it is impossible to automatically synchronize data between software platforms, making it difficult to switch vendors as well as to ensure that all parties are on the same page.
Now, a coalition of Silicon Valley law firms and startup vendors is forming to address this issue. 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. However, the coalition reflects Silicon Valley’s way of doing business – as AnnaLee Saxenian, the Dean of the UC Berkeley School of Information noted in her influential 1994 book “Regional Advantage”, the Valley is a place where intense competitors become partners and informal co-operation and exchange become institutionalized.
As such, the founding members certainly deserve praise. Eliminating inefficiencies allows the ecosystem to move faster and allows players to concentrate on creating value. However, if only founders and investors can see the data, the open cap table coalition will fall short of its potential. For the open cap table to be truly open, the information that determines equity value must be accessible to all equity holders, including startup employees.
I have written on TechCrunch in the past about the abuse potential of startup equity compensation, a highly opaque and practically unregulated market. Employees are often swayed by the allure of stock options without understanding what these securities are and how they are valued. Successful IPO stories portraying employees as instant millionaires create an impression that startup equity offers a fast track to financial prosperity. 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. The exact same is true for employee trust in the company and its leadership — miscommunication around equity issues can be detrimental. As Travis Kalanick discovered first hand, messing with employee equity can backfire.
“We are going to IPO as late as humanly possible,” Kalanick said in June 2016. “It’ll be one day before my employees and significant others come to my office with pitchforks and torches. We will IPO the day before that.” However, waiting for employees to lose their temper is a risky game; you may wake up a day too late instead of the day before. Nowadays, when it is harder to find good employees than to raise money, transparency with both capital and human capital providers is vital.
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. There was a recurring fear of liability as well as disagreement over disclosure formats. Now, when the industry’s influential players decide on a cap table format, it is possible to also form an agreement on how these data should be shared with employees. If the coalition takes on this challenge, it could easily change the industry by establishing a voluntary standard that everyone can rally around.
Capital/labor relationships in startups are inherently imbalanced, since employees contribute human capital but are denied information and voting rights. It is possible to partially rectify this imbalance by providing employee equity-holders with bottom-line information on what they stand to gain under various exit scenarios. Making information accessible and easy to understand for employees can help startups attract talent and maintain positive culture.
Saxenian’s book on Silicon Valley’s regional advantage describes also how employee stock options contributed to the transformation of Silicon Valley in 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. Today, by establishing real equity transparency, Silicon Valley can retain its competitive edge. Until the Open Capital Table Coalition engages in this challenge, it cannot claim to foster a genuinely open community.
Source: Tech Crunch