85. The Cap Table, Part 2 (John Buttrick & Sean Moran)

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Today we cover Part 2 of The Cap Table with John Buttrick of Union Square Ventures & Sean Moran of eshares. In this segment we address:

  • John, I’ve heard from many founders that get caught up in the Option Pool Shuffle. Can you describe what that is and if the eshares solution has an easy way to allocate the option pool to pre or post money?
  • I want to talk a little about employee equity. This has been a recent big topic of discussion on a number of different levels. Sean, how does eshares affect that cultural discussion.
  • John, some view the market for eshares as too small. What’s your response to them?
  • Sean, I had heard that eshares struggled to raise capital… was this the case and how have you found the process?
  • John, what was your thesis on investing and why is USV so positive on eshares?
  • Sean Moran cap tableSean, does eShares expand beyond Silicon Valley? If so, how? If not, what drives future growth?
  • Is there a data play here as well? It seems that there are many companies trying to understand and aggregate the very data that eshares will own? How are you thinking about the data angle?
  • John, any final thoughts or advice for very early-stage startups in light of today’s topic?
  • Sean, anything we didn’t touch on that you’d like to add to the cap table discussion?

Guest Links:

Key Takeaways:

1- The Basic Elements of a Cap Table
Cap Table or Capitalization Table is the record of ownership in a company.
-On the left you have the list of stakeholders including individuals or entitiies that hold securities in a company.
-Across the top you see the classes of stock. Common, Series A preferred, Series B, Options.
-You can see the outstanding ownership in a company. And aso on a fully diluted basis which takes into account preferred stock in an as converted to common basis.
-Options issued and those remaining in the pool
-Other convertible securities, such as Warrants
-Not on all cap tables but Sean thinks each should include price/share each round, which reveals the financing history and total amount of dollars invested
2- Why Ongoing Management of Equity is broken
Most often cap tables are tracked in an excel spreadsheet, which, as John mentioned, is really just a secondary source… meaning they attempting to display ownership, but are often innaccurate.Accuracy is a major issue w/ cap tables. We all have been in the situation where different revs of excel documents are emailed around and it’s anyone’s guess as to which, if any, are accurate. Eshares has changed this by acting as a primary source. It’s not just a ledger. It is a transfer agent that represents the true ownership of a company. COSTS
Clearly, it’s very expensive to have law firms manage this process… not to mention the frequent reconciliations. Plus, it seems that the savings potential on 409As can be significant.CONSISTENCY
Sean mentioned that many cap tables are organized differently and most don’t even include the price/share paid by investors. It can be very difficult to understand the funding history, total amount raised and true, fully-dilluted position of different shareholders with the standard, excel cap table. I think it goes without saying that a standardized approach with all the critical data elements can bring tremendous clarity to the equity stack.MANAGEMENT & REPORTINGIf one is an investor with multiple investments, it is very difficult to know the current value of one’s portfolio. A significant year-end process is required where one has to get all the most recent cap table, collect the documentation related to each investment and get audited finanical statements. With my current portfolio, as it stands, I can’t imagine pinging all of my founders for this information. While they may have much of it available, the communication chain alone would be difficult to manage. And this is often because all of this information is siloed. I can not view all of my positions in an aggregate manner, at once. At least, not without leveraging a tool like Eshares. And, because it’s cloud-based any investor can access the most current version at any time.And the most intriguing aspect of reporting is that Eshares allows for different scenario planning. An investor or founder can tweak assumptions like the next round’s valuation, participation, refresh of the option pool, liquidation preferece. This is where Sean talked about the tools including the waterfall analysis that allows one to create scenarios on top of an existing cap table.
3- Challenges with Employee Options

We discussed a number of issues with employee options, many of which are exacerabated by mismanagement of the cap table…

1. We discussed the option pool shuffle, which has to do w/ Options pools factored in at either the pre vs. post money valuation. A quick tip for founders… don’t let investors slip the option pool into the pre-money. It will lower the effective valuation.
2. John mentioned there are problems upon issuance of options, where board approvals are not signed at the right time
3. Paperwork is a huge hassle for those administering it at the company
4. The employees often don’t know how many options they have, how many have vested or when they vest. A very good friend of mine who is debating leaving a very well-known, Series B, company called me the other day about his options. He didn’t know how many he had and was afraid they’d know he was considering leaving if he asked for his full-diluted position and vesting status. Not good.
5. Exercising employee options can be a major process and is often delayed for months. This has been used in a predatory fasion to avoid paying out departing employees.
6. If employees know the numerator (ie. what they own in a company) they still rarely know the denominator (ie. the total shares outstanding in a company)… not to mention all the terms that impact option value.

Clearly, employees are in a difficult situation in the current environment. It’s nice to know that there are solutions that not only provide value to a company’s founders and investors but to the employees as well.


Tip of the Week:  A Simple Cap Table 

*Please excuse any errors in the below transcript

Nick: So you also touched on this option pool, and # John, I’ve heard from many founders that are getting caught up in the Option Pool Shuffle so to speak. Can you describe what that is, and if # eShares solution has an easy way to allocate the option pool to either pre or post money?

John: Well, a couple of things. I think # eShares, as #Sean just mentioned, has a tool that can give somebody who’s looking at a cap table the ability to model in an option pool dilution, you know, pre or post money. And so it provides very powerful analytic in that regard. You know, I think that employee options are another critical piece of what #eShares does. I just want to sort of give it a little bit of background. I think that historically there’s a lot of clumsiness issued, or a lot of clumsiness around issuing options. Often the board approvals aren’t secured properly, in the sense that they’re not always signed at the right time. The paper work is a huge hassle for anyone in the company that has to administer it. And the employees also don’t usually remember how many options they have when they invest, etc, etc. So it’s a huge problem for both the company and the holder. And there have been big businesses built by the brokerage companies that provide employee option services for public companies. But there’s nothing like that, as far as I know, for private companies. That’s one of the things #eShares is focused on. And so it has a whole work stream for helping companies issue options. And the employee get pinged to accept the options and then they get reminded on you know when options invest, and you could also exercise options on the #eShares platform, which is a whole another work flow. And so, I mean, #eShares can’t help the entrepreneur actually allocate the options in terms of figuring out which employees get what percentage, you know, that’s got to be a decision by the CEO and the management team and the investors. But once you come up with that allocation, #eShares can seamlessly help you implement that allocation.

Nick: Your point about exercising through the platform, that’s a, that’s a big step forward from the process today. While we’re on this point, employee equity, you know, it’s been a sort of a big topic of discussion. Lots of folks have written about it. I was just reading a post by # Sam Altman about it. #Sean, anything you want to touch on on the employee equity side that, that’s relevant?

Sean: Absolutely #Nick. And we love what, what #Sam and what #Y Combinator have done here to, to move forward the conversation. You know, we view it as fundamental to our mission to democratize I’d say not just access to equity, which we hope to do by reducing the administrative burden, but also information about it. So I mean, this is my view, maybe not the company view, but I think we can make capitalism easier. I think capitalism is a good thing and we can make it a lot easier for you know everyone involved, you know, to participate in this in the engine of innovation and value creation directly. There’s a lot of good things about private company capitalism. It’s easier to run a private company. There’s less regulatory burden, reporting requirements. But there’s this fundamental information asymmetry problem. Few people know a lot more than everyone else. So historically that has meant that there is employees that can get treated quite poorly, you know. They might not know the denominator of the total share count in the company.

Nick: Yep

Sean: They might just know the numerator, what they own. And they may not even know that. You know, I’ve heard from friends when they’re considering offers to join different startups that I get 50,000 shares here and I get 300,000 shares here. So I’m obviously going to the one with 300,000 shares. It’s like well now wait, that, that’s not necessarily better. And they may not even get additional data on , you know, the last round price, exercise price investing liquidity. So I don’t think it’s because founders or people with access to that information are fundamentally bad, you know, Locke versus Hobbes, you know, I’m with Locke. People are naturally good. I think founders don’t typically share that information because maybe they don’t understand it, maybe they’re afraid of law suits or it takes time to educate people on what that information means. So we think we can help make that easier. And it’s something that as I mentioned #Y Combinator, #Pinterest, you know, one of our customers managed by queue , brought all of their employees into the equity plan. We think what all those folks are doing is fantastic. So we have equity 101 events that we offer for employees to understand their options, get greater transparency into company equity, see what some forward thinking companies are doing. And I hope that today and maybe going forward, people will choose to work for an #eShares customer over a company that’s not because they know what it means for them as an employee. They’ll get more transparency into their equity. They can connect their bank account and extras electronically. That just, you know, empowers employees more.

Nick: #John, some view the market for #eShares as too small. What’s your response to them?

John: Well I think if you view this as a cap table company, you could reach that conclusion. But I think you have to look at it in a much broader way. We’ve talked about some of the services which #eShares can do using the cap table essentially as a trojan horse. We’ve got a huge work flow on employee options. We’ve got a big 409A practice, the biggest 409A practice in the country. We’re also developing this VC product. There, and there are many other ideas that we’re working on beyond that. So I think if, if you think of it as a brokerage for private equity or a transfer agent, you come up with a much bigger addressable market, you know. There are lots of multi billion dollar public companies in this area . There’s #DTC, which is a transfer agent. There’s #Computer Share, which is a transfer agent for public companies. When I was working in Paris I did some work for a company called #EuroClear which was the back office for trading European bonds. So I think that the addressable market here is actually quite large. And I think people may, I understand that initially you know when #Henry was looking to raise capital in the Series A, a lot of people turned him down because they really thought of this more as a cap table company. But there’s a big vision here and I have no doubt this can be a billion dollar, multi-billion dollar company.

Nick: Yeah. On that point, you know, I’d heard that #eShares struggled to raise capital. #Sean, was this the case and how have you found the process?

Sean: Sure. So some of this is before my time at the company. But I’ve heard it, you know, from #Henry second hand and from some investors as they’re considering our, purchased our, paid investor products that now they see the company’s growth and they actually regret passing it at that point in time. Now that they understand sort of the full vision. But, but you know, it’s, it’s really hard early on to you know, I ‘d been on the investing side before, it’s really hard to determine you know what a company will be you know once it grows up. I think it’s also, you’re making a big bet here. So full credit to #John and #USV team, they saw it right away, they understood, I mean, those guys really get network effects. It’s core to their thesis about investing. Not everybody sees it that way, where you know this one small thing, I agree that if we only ever do private venture backed tech equity administration, yeah there may be a okay outcome but not a great outcome, you know, there sort of is a ceiling already set. But I think most total available market, total addressable market, you know, TAM analysis, is almost always useless. I think #Bill Gurley you know in his #Uber post says you know the future if you’re doing a TAM analysis you’re assuming the future will look quite like the past.

Nick: Right

Sean: And so that, that does not take into account at all that the existing market can grow with a better product, or there’s some different economics or you know that the classic #Clayton Christensen approach to disruptive innovation, that if you can create connections that could not exist otherwise, you can create new markets. So that’s what we think we’re doing. We think that as an example secondary transactions today are heavily banker based. So there’s really not a lot of private company liquidity because it’s really expensive, it’s time consuming, you have to find you know your buyers every single time, and it just takes time. There’s no platform for this. If you could connect all of the nodes, map the private asset ownership graph, connect everyone and then reduce the administrative burden associated with facilitating that kind of transaction, then you might really have something. That might really be you know some new market potential there. So that’s what we’re looking to build.

Nick: Yeah, it’s like bad investors look at current markets, good investors look at the growth of markets and the best investors look at creating new markets.

Sean: Yeah, that’s right. Is that, that’s the #Sam Altman tweet, isn’t it?

Nick: You got it.

Sean: Yeah. We are, we definitely are excited about the kinds of things we see from #YC and from other investors that understand the way the landscape is moving. And so that’s why we love working with #USV.

Nick: So beyond all the opportunities that you guys have mentioned, I can’t help but think there’s a massive data play here. There’s so many outlets that are trying to get to the data that you guys have but, you know, they don’t have accurate, you know, verified information. So I mean, is there a data angle here that’s a part of the big picture?

John: Yeah I think there are a lot of data angles, you know. I think this is potentially a winner take all space, you know, when you look at a lot of our investments are not necessarily winner take all. They’re in winner take most areas. But, you know, think about it yourself. If you got 80 companies, don’t you want all of them to be on #eShares?

Nick: I wish

John: Or on something similar? And let’s take valuations as an example. Valuation analysis in later stage companies gets difficult. It’s relatively in the early stage, people, as long as it’s a third party financing, people generally market to the post money of that round. But in the later stage it becomes much more complicated. And you’ve been seeing examples of that in the press. Where companies like #Fidelity and #Blackrock will take dramatically different valuations of the same stock in the later stage. I mean, you know, I’m talking 50, 60, 70% difference. And so you know wouldn’t it be cool to have aggregate data on that? You know, what’s the, we have one of our later stage companies #MongoDB which was sold to a bunch of public funds. Wouldn’t it be neat to know what the aggregate valuation or the average valuation was. You know, I think that’s one example of data. But there are, there are many many examples of the data play here. And obviously that’s part of the thesis.

Nick: From either of you, any other final thoughts or advice for early stage startups or investors in light of today’s topic?

Sean: I think that’s more for #John, yeah please

John: Take, take a test drive. I don’t want to pitch, you know, too hard, but I really think this is a great product. I think it makes a lot of sense for people in the venture world that we live in to take a look at this. And everybody I’ve known who has given feedback, it’s been uniformly positive. We’ve still got things to do. We’ve got to continue to iterate and so forth. But the core functionality is, is there. Yeah, that would be my final , my final words on this.

Sean: I think for me that the lesson I learned most when I was in my short, you know, 3 year tenure in venture was trying to stay like radically open to something new. Which is really hard if you hear a lot of pitches or something sounds dumb when it’s first, you know, new. So like, you know, #Twitter I don’t really want to see what everybody had for lunch. Well that’s not really what it is. If you tried it you’d know. You know, for us, when we looked at #Snapchat it’s like well is this something that you know people are just sending, you know, dirty pictures to each other? It’s like well no if you’ve tried it then you see it’s actually something really fun and different. It’s a much different kind of company. But I’ve got to think and from what I’ve heard from #Henry when he was first pitching #eShares, it really was the sort of fundamentally different concept just to start. Which was we’re going to do all this stuff that had been done on paper electronically. Many people understood that but couldn’t see, they didn’t have the vision that he had that #Manu Kumar has also co-founded a company that they had. So #Henry had a line of sight too. Well, if we started with this building block here, the atomic unit is security issuance, here’s all the things that we could build on top of that. Which is a big leap. But I think for the right investors, they could also stay open to the possibility that okay well if you did security issuance well then you’d have on the company side the cap table, on the investor side the portfolio. Okay, what would that give you? And then just keep pulling the thread. So I think if you can try and as much as possible stay open to the possibility that there’s just something fundamentally new that’s going to transform the way we work. Because there inevitably is. And in this case, you know, #Henry had the vision to see if you were to build on top of that atomic unit what would be possible as a result. And so that’s what’s pretty exciting to us. But you know, that was the hardest lesson that I learned is just staying open to that possibility with any new thing you encounter is really a tough thing to do, but I think a valuable thing.

John: Yeah, I just want one more thing I want to say kudos to #Manu. We haven’t really talked about #Manu in this. But this was really his idea. He runs a seed fund. And he is incredibly frustrated with all the processes. And he recruited #Henry who then took it and ran with it. And I think the two of them have just done a fantastic job.

Nick: Yeah. He’s fantastic. I met him a couple times and hopefully we’ll get him here on the program too.

Sean: Oh yeah you should totally have him on.

Nick: For either of you, if we could address any topic related to venture, what topic do you think should be addressed and who would you like to hear speak about it?

Sean: We alluded to it earlier, I think there’s some, some folks getting pretty creative, I mean obviously we’re biased towards equity and what’s going on with the creative new approaches. So I think someone from #YC or #Expa, this startup studio run by #Garret Camp, the co-founder of #Uber. I think these are, you know, there’s a select group I think of incubators, accelerators, whatever term you want to use. It’s basically the new, the new finishing school I guess or the new graduate school in a way, certainly for founders. I really thing that would be interesting. I guess the other thing comes to mind is the institutional LP perspective, you know. I kind of had seen the folks you’ve had on the podcast before, I’ve certainly been a listener. #Nick, I think there’s obviously it’s a great list. I’m not sure the institutional LP perspective has been represented and just how important it is. I think #Lindel Eakman would be a great person to speak with from founder group. You know, I know #John knows #Lindel well, you know. So #Lindel previously headed up #UTIMCO’s private equity group and, you know, does direct investing too. So he knows GP and LP side. But, I think yeah probably just what creative things are the new graduate education I guess modern graduate education, what are they doing. And then maybe also something that really drives a lot of the thinking in venture and by proxy in startups. Which is the, the LP perspective.

John: Yeah I would echo that. I think #Lindel would be a great, a great guest. I know him very, very well. He was actually the first institutional LP who said yes when #Brad and #Fred were raising in 2003. Which was not a great environment for fund raising for those of us old enough to remember. It was still sort of the aftermath of the crash. And yeah #Lindel was relatively new at #Utimco at the time. And he said yes to #USV shortly after that he said yes to #Spark and he has a great perspective on venture. And he’s made investment that were very successful venture funds. And now he’s moved to founder. He could do something a little different than, than doing venture at a large, you know, public pension fund. So he would be an excellent candidate.

Sean: He’s done pretty well on those two bets, #USV and #Spark

John: And I’m sure #Nick we could help you contact him

Nick: I appreciate that guys, appreciate it very much. Alright, and then just to wrap up here, what’s the best way for listeners to connect with each of you?

John: With me, I’ve got an email john@usv.com . Everybody here is first names @ usv.com Don’t flood us with emails but I’m happy to take emails if it’s helpful.

Sean:And for me yeah sean@esharesinc.com Or I guess Twitter, you know, @seanrmoran there

Nick: Well awesome guys. Well I really appreciate you doing this, carving out the time and talking about a very important topic if not always the most sexy, the cap table. So thank you both.

Sean: Thanks a lot #Nick, I enjoyed it

John: Yeah, really appreciate it

Nick: Okay I’d like to take a moment here to provide some more detail.