Equity investments provide essential capital for growth and expansion, attract top talent through stock-based compensation, and position your business for potential future funding rounds or lucrative exit opportunities. They also come with great responsibility to manage and track that equity accurately.
If you’re new to equity management, this article will provide you with the basics: what it is, who’s involved, best practices, and the key benefits of using equity management software.
What is equity management?
When your company begins issuing shares, you must keep a distributed equity record. This ensures that you can provide all shareholders with an accurate view of company ownership.
As your company grows, the administrative and communication duties required to manage your equity become difficult to keep up with. These activities include:
- Tracking and updating ownership changes on a capitalization table (cap table) is a record of who owns what percentage of the company.
- Offering compensation plans to motivate and keep valuable employees by giving them a chance to become shareholders.
- Following legal and regulatory requirements to ensure compliance with the law and accounting standards.
- Sharing vital information with investors, such as major changes, new hires, and business milestones.
Managing your company’s equity is important in motivating valuable employees, building goodwill with shareholders, and attracting new investors. It ensures transparency and clarity in the ownership structure, enabling stakeholders to understand their ownership stakes accurately and helping to create a positive and collaborative work environment.
What do equity administrators do?
Equity administrators are professionals who can help businesses track ownership correctly and stay compliant with the law. A good equity administrator is knowledgeable about relevant regulations, has a sharp eye for detail, and is comfortable dealing with complex financial calculations. Today, software solutions are instrumental in helping equity admins gather and aggregate data that helps them see businesses in greater detail.
Generally, equity management involves these key responsibilities:
- Manage the company’s cap table: A cap table is an official document listing all your company’s securities and owners. Managing this document involves documenting equity issuances, handling exercises and transfers, and updating the cap table after events like financing rounds or liquidity events. They also share the updated cap table with relevant stakeholders to fulfill any reporting requirements to investors.
- 409A valuations: This appraisal determines your common stock’s fair market value (FMV), which helps the board establish the share price. Appraisals are a regular occurrence. 409A valuations should happen every 12 months or whenever a material event occurs, whichever happens earlier. Material events include significant changes that might influence your company’s stock FMV, such as qualified financing rounds, mergers, acquisitions, or other significant business alterations.
- Ensure compliance: To adhere to accounting standards, most companies follow the Generally Accepted Accounting Principles (GAAP) when recording employee equity issuances. They must also follow federal and state-level securities laws, including ASC 718 and Rule 701.
Who are your equity holders?
An important part of equity management is keeping accurate records of all stakeholders who hold ownership interests in the business. These stakeholders are typically categorized as follows:
- Founders: The individuals or group of people who establish the company and take on significant initial ownership stakes.
- Investors: External individuals, venture capital firms, or angel investors who invest capital in the company in exchange for equity ownership.
- Employees: Employees may be granted stock options, restricted stock units (RSUs), or other forms of equity as part of their compensation packages, making them stakeholders in the company’s success.
- Board members: Directors on the company’s board often hold equity positions and play a critical role in decision-making and corporate governance.
- Advisors: Advisors, consultants, or mentors who contribute to the company’s growth may receive equity compensation as a form of appreciation for their guidance and expertise.
- Preferred stockholders: Investors who hold preferred shares often have priority over common shareholders in terms of dividends and liquidation preferences.
- Common stockholders: The most common type of equity stakeholders, common stockholders, include founders, employees, and sometimes early-stage investors. They have voting rights and typically share in the company’s profits after preferred stockholders.
- Convertible note holders: Individuals or entities that have invested through convertible notes, which can be converted into equity at a later stage, typically during a financing round.
- Warrant holders: Warrants give the holder the option to purchase shares at a predetermined price, allowing them to become equity stakeholders if they exercise the warrants.
Each type of equity stakeholder has different rights, privileges, and potential financial gains based on their ownership position in the company. As your company grows and goes through funding rounds, the composition of its equity stakeholders may change. The constant fluctuation of ownership means having a dedicated team of professionals and a reliable platform to handle equity management is critical.
What is a liquidity event and how does it impact equity management?
A liquidity event refers to a significant occurrence that gives equity stakeholders the opportunity to convert their ownership interests into cash or other liquid assets. Examples of liquidity events include an initial public offering (IPO), where a private company goes public, and an acquisition, where a larger company purchases the startup.
Liquidity events can be a powerful tool for both equity holders and the companies they invest in, especially when managed properly. Understanding all potential impacts on ownership structure, financials, and voting rights is key for any equity holder looking to make informed decisions during such events. Part of good equity management involves having the right software tools and processes that give stakeholders the best possible insights into their investments when a liquidity event occurs.
Equity management best practices for startups
Equity management is a critical process that can’t be ignored or mismanaged. As you get started on your equity management journey, here are some best practices to keep in mind:
- Maintain an accurate cap table: Keep an up-to-date cap table that records all equity issuances, transfers, and changes in ownership. Regularly review and reconcile the cap table to ensure accuracy and transparency in the company’s ownership structure.
- Have a process for remaining compliant with legal and regulatory requirements: Stay informed about securities laws and accounting standards relevant to equity management. Comply with reporting obligations, including those associated with 409A valuations, to ensure that equity issuances are properly valued and aligned with regulatory guidelines. Equity management software can be a useful tool for staying current with requirements and identifying small errors that could have big legal implications.
- Keep an open line of communication with stakeholders: Have a clear process for keeping all equity stakeholders informed of their equity plans, vesting schedules, and any potential liquidity events. Providing regular updates about changes in ownership and other equity-related matters helps build goodwill and confidence in your company.
- Implement equity management software: In the beginning, an Excel spreadsheet may be all you need to track your company’s equity distribution. But as your company grows, so will the complexity of equity management. At some point in your journey, you’ll likely start taking advantage of specialized equity management software to minimize the time and potential errors that come with trying to manage your company’s equity manually in spreadsheets.
The benefits of using equity management software
Equity management software offers numerous benefits for startups and companies of all sizes. These platforms help streamline the entire equity management process, from issuing equity to stakeholders, tracking vesting schedules, and maintaining an accurate cap table. This increased efficiency reduces the risk of errors and ensures compliance with regulatory requirements.
Equity management software also enhances transparency, enabling stakeholders to access real-time information about their ownership interests. Finally, the software’s automation and centralized data storage help simplify communication with employees, investors, and other equity holders, facilitating seamless reporting and updates.
Learn more about how Astrella equity management software can save time, minimize administrative burdens, and promote a smoother, more organized approach to equity management.