Are Capitalization Tables the New Social Networking Tool for CFOs and Lawyers?
Gary Levine - We all know that CFOs and lawyers are not considered the most social bees of the bunch. But we do read the Wall Street Journal quotes that talk about how the CFO or General Counsel is concerned with “what’s in the best interests of the stockholders.” The same is true at venture-backed and other non-public companies. Investors, board members and senior management want to know how their actions will affect their stockholders, whether they’re thinking about a new round of financing, a merger or acquisition, an IPO, or just granting more employee stock options.
So perhaps in some small way, capitalization tables just might be the perfect social networking, Web 2.0 application for the financial set. While it’s clearly not MySpace, Facebook or Twitter, in a venture-backed or employee-owned company, your “friends” are your fellow stockholders and investors, to a certain degree. And you can understand who’s who simply by looking at the capitalization table. Because in the cold light of day, if they’re not on the cap table, you’re just not interested. And when there’s a small change, a new face, or an upcoming get-together, you want to be the first to know.
For many years, Two Step Software has been hearing from customers who tell us that creating up-to-date, fully-diluted capitalization tables is a time-consuming and complex challenge, normally done at the last minute before a board meeting or potential transaction. We’ve helped thousands of companies convert that challenge into a couple of clicks, with the ownership and governance information for more than 100,000 companies now tracked in our software applications.
However, over the past 6-12 months, we’ve noticed a trend whereby CFOs are clearly looking for better ways to work with their law firms, auditors and other service providers when it comes to stockholder and option plan management. It’s always the convertible or ownership instruments with some type of vesting that cause the most difficulties. In the past, each person maintained their own copy of the capitalization table on their own set of spreadsheets, hoping to get timely updates from the others and incorporate the changes as needed. But there’s no question that this method was time-consuming, error-prone, and inefficient.
What seems to drive the new focus on working together more efficiently are the accounting requirements of equity compensation reporting under FAS 123R. Under the new rules, there is no longer a practical way to separate out stock option administration, stockholder tracking and equity compensation reporting, since every change potentially triggers an accounting update. Option grants, vesting events, cancellations, forfeitures, exercises, and terminations all have an effect on expense amortization. Therefore, to a greater degree, administration and expense recognition must be on a record-by-record basis (rather than grouped by grants on a specific date, as in the past). There must be more coordination between stock and option administration and equity compensation reporting. Now more than ever, it matters how and who is tracking the option grants, exercises, and cancellations as well as the stock issuances related to employee exercises.
At a recent Two Step webinar entitled “Making Stock Option Reporting Easier for Lawyers and Their CFO Clients” which was attended by over 100 CFOs and legal professionals, more than 40% of those responding to a poll indicated their law firm does all or some of the stock and option administration. To a follow-up poll, over 65% of the respondents indicated that it’s difficult to coordinate between the law firm and the finance department of the company or that the process is too manual.
To illustrate this point, Two Step prepared a case study of one of its Silicon Valley, high-tech customers, Iconix Inc. Iconix indicated that by moving their stock and option administration and accounting to a central location—through the use of our on-demand application, Equity Focus, and by improving the collaboration and coordination process with their law firm—they were able to save $600 per option grant in legal fees, thousands of dollars in audit fees, and numerous hours of CFO time.
The simple lessons we’ve learned from our customers are:
- Avoid Multiple Copies: Transferring spreadsheets between parties is inefficient, error-prone and frowned upon by auditors and boards of directors.
- Connect the Data: Equity compensation valuation and expensing must be dynamically connected to stock and option administration.
- Update In Real Time: All data changes must update reports and capitalization tables in real time to avoid errors or delays in decision making.
- Make It Easy to Share: The information and documents that support the capitalization tables should be stored in a central location with easy, browser-based access for authorized parties.
- Document Your Process: The responsibilities of each party in the stock plan administration and equity compensation reporting process must be managed effectively and set forth in a written game plan.
These five lessons are very easy to implement for any company willing to take the time to consider their game plan. Think of all the hours you’ve wasted in the past. By investing a few hours in planning the information management process for stock plan administration, equity compensation reporting and total capitalization management, you can save hours of CFO time and thousands of dollars in legal and audit fees. In the end, capitalization and equity compensation information flows directly into your company’s financial reporting. From a control perspective, getting it right is the smart thing to do—and it’s more important than ever under the new risk assessment audit standards.
Not to mention, with all the time saved, you can get home earlier to work on your Facebook page.