The Way Startups Track Stock Ownership Is Totally Broken
euforic services via flickrStartups usually have a lot of partial owners: founders, investors, and early employees.
Unfortunately, a lot of startups do a terrible job of tracking who owns these shares, and this creates big problems down the line.
eShares helps privately held companies build their capitalization table, or "cap table" - the official record of who owns what. Because eShares helps companies clean up their cap tables, they see a lot of broken ones along the way.
Ward breaks the problem down into four main buckets:
- Most cap tables are wrong. A lot of companies track share ownership in Excel or Google Sheets, but fail to keep those spreadsheets up to date as they issue new shares and options. Cleaning up a dirty cap table is pretty expensive for a startup - between $5,000 and $15,000. So a lot of startups don't bother to do it, or don't do it regularly enough.
- Investors don't track their stakes very well. This is partly because most startups never issue stock certificates. Also, a lot of investors know only how many shares they hold, not the total number of shares issued, so they don't actually know the percentage they own. New stock issues and splits complicate things even more.
- Note holders are often forgotten. Some early investors loan startups money in the form of a convertible note - debt that is supposed to convert to partial ownership when the company raises a later round. But a lot of companies misfile or incorrectly record these convertible notes, and less sophisticated investors don't track them.
- Early employees often don't take advantage of the equity they were granted. There are a lot of reasons for this, including lack of information, poor tax treatment, and the inability for quitting employees to pay cash to exercise their options. Ward also says that a lot of companies simply don't want to bother with the legal fees necessary to allow employees to exercise stock options early, which means employees don't get the same preferential tax treatment as founders.
This fourth point is particularly troublesome because a lot of employees at tech startups take a lower salary than they'd get at a big company like Google, in exchange for equity - they're basically betting a few years of their careers on a chance at a huge payoff. But these problems mean they may not get the payoff they were hoping for even if the company goes big.
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