Learn more about Rule 701, recent updates, and how to stay compliant at your company. Everything from the history of Rule 701 to the most recent changes.
Every cap table problem stems from two basic sources: lack of institutional control and excessive versions. Having to request your cap table from a law firm is a barrier to consistent and accurate updates. And once you have made any change, it can be difficult to remember and communicate which version is the most up-to-date. These challenges cause almost every cap table that is on Excel to have mistakes.
At Carta, we take cap tables in Excel and input them onto our software platform. During this process, we correct many errors. Here are the most common ones:
1. Dates that don’t agree
The date a stakeholder exercises their options and the date their stock certificate is issued should be the same. In many cap tables, there is a delay between the two dates. Using software that allows you to issue shares electronically is one of the easiest fixes to this issue.
2. Not tracking transactions
Many employees and investors have multiple option grants. When issuing shares, it’s critical to track which option is being exercised to create which certificate. The option ID number needs to match the corresponding stock certificate. If it doesn’t, tracking transactions become extremely difficult. Additionally, this leads to improper exercises and potential tax consequences to the company and employee.
3. Wrong or varying entity names
When dealing with stock certificates, you have to be exact. Oftentimes cap tables use abbreviated or incorrect names for the same person or company. For example, entering a stakeholder as both Mary Stuart and Mary C. Stuart, or using both ABC Ventures and ABC Ventures Fund. Shortened titles and varying forms of an entity’s name that do not match its legal name can cause confusion and lead to canceling or replacing mislabeled stock certificates.
4. Not asking your legal counsel when you have questions
Thanks to new, intuitive equity management tools, equity admins can make a lot more changes on their own without fear of messing up. But when it comes to complicated changes, like ISO to NSO conversions, equity buybacks, and more, it’s worth spending the money to consult your legal counsel.
5. Not tracking terminations and exercise windows
When an employee leaves a company, many actions are put in motion. These all need to be managed and tracked. If cap tables are not closely managed, employees could exercise options outside of their permitted window. They also could purchase more shares than what they have vested. We see this happen all the time. When an employee early exercises their options, then the repurchasing of unvested shares by the company needs to be done clearly, efficiently, and with proper tracking.
6. Founders not understanding liquidation preferences
This is a big one that can profoundly affect a company. Founders often inadvertently increase their dilution without realizing it. All it takes is one cumulative dividend or participating preferred to really dilute the common shareholders. The cap tables that people build out on their own almost always only show number of shares, not fully diluted percent ownership, so it’s easy to lose track.
7. Not accounting for option expenses when updating their cap table (no pun intended)
Many founders don’t understand that there is an expense associated with every option granted that hits their balance sheet. Careful consideration should be taken on expense implications of new awards as well as modifying old awards. Guidelines that dictate expense methodologies for most awards, like ASC 718, are tough, but important to follow and track.
8. Issuing options without a defensible fair market value (409A)
A 409A valuation will set the fair market value of your shares. Some founders make the mistake of issuing options without a 409A or outside of their 409A safe harbor period. This can often lead to negative tax implications for both the company and the employees who received these awards.
9. Forgetting Rule 701 and Form 3921
If you are a larger company and you pass the Rule 701 threshold, you need to make the proper Rule 701 disclosures. Many companies don’t even realize this is a requirement until after they have passed the threshold. Form 3921 for ISO option grant exercises needs to be filed for the calendar year in which those exercises occur.
10. When transitioning to a cap table management software, forgetting to track previously granted paper certificates
Without tracking paper certificates, the same stock could be issued twice accidentally. Companies and law firms forget what’s been sent out, have to make corrections, and end up Fedexing certificates back and forth, losing track of important information.