Most founders know the basics around capitalization tables (“cap tables”), insofar as they are used to reflect who the owners of the company are, how much of the company they own and what type of equity they own in a company.  What lies below the surface of that, however, can be much more complicated and the impact of not understanding the mechanics surrounding the cap table and equity can be disastrous for founders.  Here, we discuss three of the top issues that are often overlooked by founders – and how founders can start to address them.

• Not Understanding the Full Landscape of Options when Issuing Equity.  Founders are consistently approached by employees, advisors and others who are asking for a “piece” of the company – for example, an advisor may say he wants 50bps [basis points] in exchange for his advisory services or an employee may say she wants an ownership stake in the company to really feel like she is part of the team.  But what does that mean in actuality and what choices do founders have when faced with these questions?  The threshold questions for founders to consider here include: (1) first, determine what type of equity you are comfortable issuing (e.g., Restricted stock?  Stock options?  Something else?), (2) second, determine whether the company has enough authorized but unissued shares in reserve to properly issue those shares (or, if not, what the process is for approving and amending the charter documents for the company to increase the number of authorized shares), (3) third, determine what approvals are required and what the process is surrounding the issuance of shares and (4) fourth, determine whether there is any vesting schedule associated with the issuance (e.g., ¼ of the shares vest one year after the vesting commencement date and the balance vest in equal monthly installments over the next three years) and whether there are any other restrictions that will be associated with the shares (e.g., transfer restrictions or buybacks) or whether any repurchases or forfeitures of equity or options will be imposed in connection with termination of employment.  Too often, founders wish they had more fully investigated the implications of the various types of equity issuances before they issued equity.  Additionally, one of the biggest issues that founders deal with is the cumulative effect of founder dilution.  For example, a company may have an option pool capped at 10%, but when that pool runs out, the founder may not be in a position to simply stop granting equity awards.  In fact, a founder may feel compelled (or may even actually be contractually required in connection with an investment round) to expand the option pool to make more equity available to employees and advisors – and expanding the option pool will typically in turn dilute the founders’ (and other existing stockholders’) equity ownership in the company, unless the founders and the existing stockholders also contribute sufficient capital in that new round.  So, one of the most important tasks for founders to anticipate is how much equity will be granted to employees and advisors, taking into account the company’s expected growth stages and timelines, and what impact that will have on diluting the founders’ overall equity ownership in the company.
• Not Understanding Applicable Mechanics. Before issuing equity to an advisor, employee or anyone else, the founders need to understand whether the issuance will be made on a fully-diluted basis or not.  For example, let’s assume that an advisor is seeking to receive shares representing 2% of the company upon issuance to the advisor (the "Issuance").  Here, it is imperative that the founders and the advisor are on the same page as to what the “2%” is actually based on, i.e., whether they mutually intend that after the Issuance to the advisor, the advisor will have received shares that represent simply 2% of the total of the number of shares issued and outstanding immediately prior to the Issuance, or whether they mutually intend that the 2% will also include (i) the number of shares that would be issued to all stock option holders if they had exercised their options (adjusted in each case for any antidilution rights inherent in those options) in full simultaneously with the Issuance and (ii) the number of shares that are issued to the advisor in the Issuance. The impact of a misunderstanding can be drastic, and without ensuring that the parties are on the same page, one side might receive significantly more/less shares than initially intended.  Additionally, it is critical that founders understand how warrants, “SAFEs” (Simple Agreements for Future Equity) and other instruments function, and also that founders take the time to model out how these instruments, as well as any preferred stock / liquidation preferences, impact the distribution waterfall (and, in turn, the money the stockholders may expect to receive at the end of the day upon a distribution or liquidation event).
• Not Following Corporate Formalities. We know that corporate formalities may seem like a tedious chore at best (and at worst, an expensive and time-consuming distraction to founders), but a little time upfront to issue stock properly generally saves the founders from significant costs and headaches down the road.  For example, we have seen founders issue stock options to employees without the guidance of lawyers – only to later discover that the company never formally adopted an option plan and, accordingly, the validity of those stock options is at risk.  We have also seen founders use forms that are not appropriate for the transaction at hand, which can lead to unintended consequences (such as using a form that has a more favorable vesting schedule than intended or accidentally includes preferential terms that were only intended for preferred investors).