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The Gap Table: A Discussion on Capital Table Management

As part of our Founders + Funders SF 2019 summit, held in partnership with Seneca VC, we brought together an exciting group of startup founders and investors for a day of learning, networking and growth.

Emily Kramer, VP of Marketing at Carta, walked us through an excellent discussion on capital management, including its role in addressing the gender gap in founder equity. Carta and #ANGELS recently conducted a study on how to analyze a cap table and make sure biases are removed when a startup is thinking about equity compensation.

In case you were wondering, the numbers in terms of the value of equity owned by women are, in Emily’s words, “really, really bad”. In fact, only 9% of founder and employer current equity value is owned by women.

Luckily we had a room full of people committed to changing this ratio…..


Understanding capital tables, equity, and ownership

First, cap tables are really confusing. They start off simple. They usually start off with just co-founders, how much each owns. And then over time, they become the source of truth for all equity transactions….and they get a little messy.

You start having ownership percentages and dilution. Every time you raise a round, these things change again. And then what happens – especially if you’re doing this in a spreadsheet – it’s going to get complex really fast.

When it gets complicated and/or wrong, it’s really hard to tell if you are removing bias from equity compensation for these shareholders, especially the employee shareholders. So not only are cap tables complicated, but valuing equity is complicated.

One of the reasons we’ve only ever been able to talk about the salary gap is because equity compensation is really hard, and nobody has the data on it. When you’re thinking about the value of equity, it’s important to think about post-money and pre-money valuations. The basic thing here is that when you’re calculating your ownership percentage, you’re doing it often at a post-money valuation.

The next important thing to know is that your ownership percentage is going to change over time, it’s going to get diluted. And finally, if you do have an exit, assuming it’s awesome, everybody is going to get money back. But if it’s not so awesome or even mediocre or even kind of okay, you’re going to use these liquidation preferences. Obviously, investors get paid out first, and employees get paid out last.

There are a lot of complications in saying, “Well, what is the value of my equity worth right now when I’m thinking about these liquidation preferences and when I’m thinking about the fact that my company might raise a round soon?” This is really confusing for founders. This is really confusing for employees. It’s even confusing for employees that work at a company like Carta.

An option pool is the amount you set aside to issue to employees or to issue common stock. You primarily do these option pools or set up these option pools when you’re raising a round, so that every time you issue options to employees, you’re not having to recalculate ownership percentage and dilution. You set this off in advance, and that means you have that dilution calculation happen once. There are some times between rounds where you might need to go back and ask your board to increase the size of your option pool. We did that at Carta last year to make sure that our equity compensation was fair. We did an equity leveling exercise that required that. [Slide 8]

Now you get into calculating the value of employee equity. It’s a seemingly simple math problem that you can put five million different numbers into. It can be confusing.

In reality, there are four options, and simply put, it’s the current value of the stock minus the strike price equals the value of an employee option. When we’re giving offers to candidates, we recommend that they take the most recent preferred price as a proxy for the current value of stock to figure out the value of their options. You multiply that by the number of your options, and we call that the notional value. Basically, if you were to get bought today, the most recent preferred price is a pretty good proxy for how much that might be and how much your options might be worth.

On the other hand, for our gap table study, we use the current FMV (fair market value) or the strike price, which is significantly lower than the preferred price, which is why we don’t recommend you use it when you’re telling employees how to value their equity. The main thing to know is that there are a lot of different ways to value options, and you need to have a framework and a way to explain that to your employees.

First off, for valuations, if you’re just starting a company, you might not know that you’re required to get a 409A not just every time you raise around, but also every year. So you’re consistently setting new strike prices. And this [Slide 12] is just an example in Carta that shows how these go up over time. Our platform made it a really great way to value options in a large-scale study like the gap table, because we had regular updates from all the companies on our platform because they’re required. And because we were looking at percentages and not just raw value, this was an easy way to do it. But again, I don’t recommend telling your employees to estimate the value of their options based on the FMV, because it will seem really low.

Back to employees, switching back and forth between two ways of valuing options here, the FMV way and the preferred price way. This is how we tell employees in our literal offer letter. We tell them how to calculate the notional value. We give them the information to be able to do that. We would have given them the strike price, but we had just raised a round, so we didn’t know. We give them all of this information so that they can evaluate their offer and hopefully evaluate other offers as well. We provide a template of this offer letter on our blog. It explains how equity works, which we think is a key way to start leveling the playing field across employees on evaluating their equity offers.

The gap table and compensation

In tech, compensation is more than just salary. Sometimes it’s salary plus bonus plus equity. Often, it’s just salary plus equity. Rarely anymore is it just salary.

We had this unique opportunity to collaborate with #Angels, which is an investment collective, to do a study last year on equity compensation by gender. They knew we were sitting on this goldmine of data, and wanted to tap into it. I said, “Absolutely.” I’d been there for like six weeks. We didn’t have a marketing team. We were 325 people at Carta, and I was like, “This is going to be my main project. I just think it’s so important.” So that’s what we did. We’re going to do it again this year as well.

Really quick notes on methodology [Slide 15]. The value of an option here is the common stock, FMV, minus the strike price. We didn’t have gender data at Carta, so we got creative. We matched names against the US Social Security database. This is imperfect and led to us having to remove about 13% of names. And if you had a gender-neutral name, like Jamie, and it wasn’t 85% associated with one gender, we just removed it. The biggest bummer of this system is that it only had male and female genders, and gender is non-binary.

We would have loved to have been able to include that in the study, but we couldn’t, given the limitations. We cut it down from our overall numbers on Carta, given a lot of these constraints, but we had a statistically significant amount of people in the study.

Here are the results for employees and founders [Slide 16]. This doesn’t include investors, we’ll hopefully have that this year. We’ll have that this year.

Female employees own 47% for every dollar male employees own in current equity value. How this breaks down is, of equity holders (people on the cap table), 35% of those people are women, but the value of that equity is only 20%.

The pie chart all the way over on your left, we want that to be 50/50, right? I would think so. I’d like it to be 75/25. My day might be a little bit better [laughter]. But we need that to be 50/50. Or dreamworld, that’s even a higher percentage. We have two problems here:

  1. We need to get more women on the cap table
  2. We need to make sure that they’re given equal equity compensation

So that 47¢ goes all the way up to $1.

For founders, it’s bad news. It’s really, really bad. 13% of founders on cap tables are women. It’s 6% of founder equity. It’s 39¢ on the dollar. Crazy. I don’t even know what to say. I don’t really understand why it’s so bad.

We have one quote was from the CEO of Carta [Slide 24]. He’s a man. He did not start on diversity early, and he didn’t realize how important it is to start early. Well, obviously, it’s important to start early, and we need to start talking, and we need men to start talking, about the fact that you need to start early.

Second of all, Sarah Mauskopf, who’d spoken earlier in the day, shared Winnie’s gap table information after we did the study, and she said, “When you start early and you have women investors, and women founders, and early women employees, you don’t end up in this situation.” A lot of people here are, probably, early stage founders. Some of us are in the situation where you are late stage, and then what do you do?

The things that you do when you’re late stage and you analyze your cap table are actually pretty simple. You list everyone on your cap table. You put in gender, you can put in ethnicity, you can put in role…..anything you want to do to analyze and run these calculations. Once you do that, if you realize you have a problem, what are your options? You can’t go back in time. You can’t hire a bunch more women and swap everyone out. It might be really hard to get female executives when you have none, or it might be hard to get female board members when you have none.

Equity leveling and option pools

One thing that we did at Carta when we realized we were moving in the wrong direction was we did an equity leveling exercise, much like you would do a salary exercise where you take every employee and put them into a level and assign a salary band. We did that for equity.

When you do that for equity, you now have bands for when people start. If someone is at a Level III, they’re in a particular equity band. You not only should do that for the new employees that come in, but for everyone.

If you’re lucky enough to be able to increase the size of your option pool – we did by $1 million to do this – you can actually go back and do refresh grants. Last year, we did refresh grants for a large percentage of employees for the sole purpose of getting everyone in the same level, so the 50th percentile or greater on equity based on Radford data. What that means is we tried to make it right for everybody to remove bias. That means that everyone that works for Carta now, although they might say, “There aren’t enough women here. There aren’t enough underrepresented minorities here,” what they can’t say is that, “I’m not compensated fairly.” That’s a big way to improve what you’re doing.

The other big thing that we all need to do is talk about this. We need to talk about this, and we need to talk about how we can fix it, and we need to support each other, invest in women-led companies, hire women. If you’re a manager, hire women. If you’re a CEO, choose women investors. Everything. We all have to work together. It’s a Herculean effort because it’s 9% to 91%.

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