This is an important task for startups, because they’re raising a lot of money, sometimes millions or even tens of millions of dollars. You need to make sure that you’ve collected the money for the ownership you’ve sold, such as shares, convertible debt, SAFE notes, or any other securities. There’s nothing worse than giving people ownership in your company and then not getting the cash. If you haven’t reconciled your capitalization (cap) table, and you didn’t collect all the money you were supposed to, you could find yourself in an embarrassing situation. Several months later, you have to go back to investors or your board and say, “We didn’t get all the cash we were supposed to get.” Or you have to tell them, “This fund still owes us $250,000.” Or “This angel investor who’s putting in 50K just disappeared, but they have executed ownership documents.” That is a very uncomfortable conversation.
This happens more than most people realize. Frequently companies come to us, and they weren’t doing accounting before, or maybe just not using a very good firm. We reconcile the cap table and you would be shocked at how many investment dollars we help them recover. So don’t make that mistake.
What is the fund collection process?
Starting from the beginning, when someone invests in your company, you’re typically selling them four types of ownership: preferred shares, common shares, SAFE notes, or convertible debt. It’s a security exchange – you get cash and they get the securities.
Cash comes to your startup in two different ways:
- An escrow account. Your lawyer will set this up, and give all the information to investors to let them wire the money to the escrow account. Once those funds come in and the attorney checks it, they will release the money to your company’s bank account. This happens most often with large fundraises.
- Direct wire transfer. The most common way a startup receives funds is by having them directly wired to the startup’s bank account. This actually makes it easier to reconcile, because your accountant can see the wire transfers in your account and also see the names of the investors sending the funds.
What causes cap table discrepancies?
At that point it’s very important to review the legal documents, like stock purchase agreements, and match them line by line to the capitalization table. The stock purchase agreements and the cap table should match perfectly.
Most of the time it’s all there, but occasionally we find something wrong or money missing. The reasons for missing funds typically fall into four areas:
- Bad wire information. Sometimes the transfer bounces because there’s a typo in the wire information or the wrong information gets sent.
- Multiple transfers from the same entity. Sometimes multiple entities from the same venture capital fund will invest in a startup. So VC fund one and VC fund two are splitting the ownership. Or there is another sub entity from that VC firm that’s investing. So your company might get two or three wires from the same VC firm, and one of those entities may have incorrect wire information.
- Human error. Someone may have simply forgotten to wire the funds, or was out sick, or overlooked it for some reason. This isn’t common but it does happen.
- The attorney didn’t reconcile the escrow account. If your funds are going through an escrow account, your lawyer should be doing the same line-by-line check that your accountant does. If that’s not done correctly transfers may be missing.
Be careful with your startup’s funds
The cap table should be checked regularly. If you’re working with a good accounting firm, they will reconcile a cap table every month. That’s our process at Kruze Consulting. But if you’re working with a less experienced firm or you’re doing this all yourself until you can afford to work with an accounting firm, these are the things to watch out for. Again, it can be very embarrassing when you don’t do this, and you need that cash. So make sure you get it. If you have questions on reconciling a cap table or other accounting issues, please contact us.