SOP for Cap Table Audits: A Comprehensive Guide for Carta and Pulley Users

Your cap table manages your equity (which is the foundation of your company's value).

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As a startup, having a simple, automated cap table is important for managing your equity. The complexity of legal jargon, valuations, and cap table calculations can make audits daunting.

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That's where this guide comes in.

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Read on to discover the Standard Operating Procedures (SOP) for conducting cap table audits, especially for users of two popular cap table management platforms: Carta and Pulley.

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What is a Cap Table Audit and Why is It Important?

A cap table audit involves thoroughly examining and verifying a company's capitalization table, commonly known as a cap table.

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A cap table is a detailed ledger that outlines the ownership structure of a company, including the distribution of shares, options, warrants, and other equity instruments among shareholders, founders, employees, and investors.

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For startups, a cap table is an important document that allows both founders and investors to make informed decisions about the company. Therefore, cap tables are typically created early in the startup or venture process, often before other company documents.

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The cap table audit is important at the various stages of the growth of a company. Some of its benefits include:

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Accuracy Verification

A cap table audit is used to confirm that the information recorded in the cap table is accurate and up-to-date.

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This includes verifying the number of outstanding shares, the ownership percentages of shareholders, the terms of equity grants, and any changes resulting from financing rounds, stock option exercises, or equity transactions.

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Compliance Assurance

Companies are subject to different legal and regulatory requirements governing equity issuances, transfers, and disclosures. A cap table audit helps ensure compliance with these requirements, including securities laws, tax regulations, and corporate governance guidelines.

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Decision-Making

Accurate and reliable cap table data helps in making informed business decisions, especially those related to fundraising, mergers and acquisitions, stock-based compensation, and corporate governance.

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A cap table audit provides stakeholders, including executives, board members, investors, and legal advisors, with confidence in the integrity of the cap table. This helps them to make strategic decisions based on reliable information.

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Investor Confidence

Investors use the cap table to assess the ownership structure of a company and evaluate the potential return on investment.

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A cap table audit demonstrates the company's commitment to accurate record-keeping and regulatory compliance, thereby enhancing investor confidence and facilitating capital-raising efforts.

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Risk Reduction

Inaccurate or outdated cap table information can lead to misunderstandings, disputes, or legal challenges among stakeholders, potentially disrupting business operations or jeopardizing corporate transactions.

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When you conduct regular cap table audits, you can identify and rectify discrepancies, errors, or inconsistencies proactively, reducing the risk of costly disputes or compliance issues in the future.

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When Should You Carry Out a Cap Table Audit?

A cap table audit is usually done before major corporate transactions. A common mistake is postponing the audit until the last minute, which can lead to rushed reviews and insufficient time to resolve discrepancies.

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Ideally, a cap table audit should be performed during the company's first issuance of preferred stock and updated before each subsequent round or annually.

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You can also conduct an initial audit during a data migration when transitioning to a new tracking system. Conducting an audit at this stage ensures that the data entering the new system is accurate, thereby preventing the need for extensive historical cleanup later.

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How to Conduct a Cap Table Audit Using Carta

Alt: carta cap table management

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Carta is a cap table management and valuation platform that simplifies the complex process of tracking equity ownership.

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The platform offers a suite of tools designed to automate and streamline cap table management, including features for issuing and managing stock options, preparing for audits, and ensuring compliance with regulatory requirements.

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Here’s how to carry out a cap table audit using Carta:

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Step 1: Access Your Cap Table in Carta

Open your web browser and go to Carta's official website.
On the top right corner of the homepage, you will find the "Sign In" button. Click on it to proceed to the login page.
Input your registered email address and password. If you have two-factor authentication enabled, complete the additional security steps required.
After successful login, you will be directed to your main dashboard. This dashboard provides an overview of your account, including recent activities, alerts, and quick access to key sections.
On your dashboard, you will see a navigation menu typically positioned on the left side of the screen. Look for the tab labeled "Cap Table."
Click on the "Cap Table" tab to enter the cap table management section. This section comprises all the detailed information regarding equity ownership, stock issuances, and other related data.

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Step 2: Review Equity Issuances

This step ensures that your company's records accurately reflect the ownership structure and comply with all legal agreements. Follow these steps to review equity issuances using Carta:

List all types of equity that have been issued. This usually includes common stock, preferred stock, options, and warrants. Carta provides an organized view of these in your cap table.
Cross-reference the equity issuances recorded in Carta with the original documentation. This includes stockholder agreements, board resolutions, and any other legal documents that authorized these issuances.
Ensure that each issuance recorded in Carta matches the details in the official documents, including the number of shares, issue date, and recipient information.
Ensure that no equity issuances are missing from the cap table. Sometimes, smaller issuances or earlier transactions might be overlooked. Conduct a thorough review of historical records to confirm all transactions are accounted for.
Verify that the correct share classes and series are recorded. For instance, ensure that preferred stock is accurately categorized into its respective series.
Confirm the number of shares issued for each transaction. Ensure that the total share count in Carta matches the authorized number of shares.
Check the ownership percentages to ensure they align with what was agreed upon at the time of issuance. This is crucial for understanding dilution effects and the distribution of ownership among stakeholders.
Verify the issuance dates recorded in Carta. Ensure they match the dates on the official documentation.
Confirm the issuance prices and any related terms (e.g., discounts, vesting conditions). This is especially important for maintaining accurate financial records and for tax purposes.

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Step 3: Audit Option Grants and Vest Schedules

When auditing option grants and vesting schedules, you need to confirm that all option grants have been accurately recorded in Carta. Follow these steps:

Gather all relevant documents related to option grants, such as board resolutions, option grant agreements, and any amendments. Ensure that you have the complete set of documents for each grant.
Log into Carta and go to the section where option grants are recorded. Compare the information in Carta with your physical or digital records. Important details to verify include:

Grant Date: Ensure the grant date in Carta matches the date approved by the board.
Number of Options Granted: Confirm the number of options granted to each employee or stakeholder.
Exercise Price: Verify that the exercise price is accurately reflected and complies with the terms of the grant agreement.
Option Holder Information: Ensure the option holder’s name, contact information, and other relevant details are correctly entered.

Confirm that all option grants have been approved according to your company’s procedures and comply with relevant laws and regulations. This includes checking for any necessary board or stockholder approvals.

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Step 4: Confirm Convertible Instruments

Convertible instruments, like convertible notes and SAFEs (Simple Agreements for Future Equity), are important components of your cap table.

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These instruments can have a huge impact on the ownership structure upon conversion into equity. Hence, you need to thoroughly review and confirm the details of these instruments during your cap table audit.

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Here’s how you can do this using Carta:

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Steps for Reviewing Convertible Notes

Go to the "Convertible Instruments" section in Carta.
Ensure you have a comprehensive list of all convertible notes issued by the company.
Check that the principal amounts and interest rates recorded in Carta match the original agreements.
Confirm that interest accruals are accurately reflected up to the current date.
Ensure that the maturity dates of each convertible note are correctly recorded.
Identify any notes that are approaching maturity and need attention.
Examine the conversion terms, including the conversion price, cap, and discount rate.
Ensure these terms are consistent with the agreements signed by investors and are correctly entered into Carta.
Use Carta’s simulation tools to model different conversion scenarios.
Assess the impact of these conversions on the company’s equity structure.

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Steps for Reviewing SAFEs

Locate the SAFEs section in Carta to get a list of all SAFEs issued.
Confirm that the list includes all agreements.
Check the amount invested and any valuation cap or discount terms.
Ensure that these details are consistent with the original SAFE agreements.
Review the trigger events that will cause the SAFEs to convert into equity, such as future financing rounds.
Ensure these events are well documented and tracked in Carta.
Use Carta to simulate the conversion of SAFEs under different scenarios.
Understand how these conversions will affect the cap table and the ownership percentages.

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Step 5: Verify Transactions and Ownership Changes

Log into your Carta account and access the transactions tab from the main dashboard.
Use the filter options to narrow down the transactions by the specific date range you’re auditing. This will help focus on recent changes and ensure nothing is missed.
Review each transaction entry carefully. Compare the details in Carta with your internal records, such as board meeting minutes, stock transfer agreements, and stock certificates. Ensure that:

The type of transaction (issuance, transfer, cancellation) is correctly recorded.
The number of shares or options involved matches the corresponding documents.
The dates of the transactions are accurate and correspond with your records.

Document each issuance and transfer of shares. Confirm that:

The number of shares issued does not exceed the number of authorized shares outlined in your company’s charter.
All issuances and transfers have the necessary board approvals. Check the board resolutions and meeting minutes to verify that the transactions were authorized.
The terms of the share issuances and transfers comply with any existing shareholder agreements.

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How to Conduct a Cap Table Audit Using Pulley

Alt: pulley cap table management

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Pulley is a cap table management tool that is designed to simplify and streamline a cap audit process. Its robust features allow companies to accurately manage their equity, automate complex calculations, and generate comprehensive reports.

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Here’s how you can conduct a cap table audit using Pulley:

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Step 1: Review Shareholders and Equity Grants

Review the details of each shareholder listed on your cap table. This step ensures that all shareholder information is accurate and up-to-date. Here’s what to check:

Full Names: Ensure the full legal names of all shareholders are correctly spelled and match their identification documents.
Contact Information: Verify that contact details such as email addresses and phone numbers are current.
Addresses: Confirm that the residential or mailing addresses are accurate.
Shareholder Type: Distinguish between different types of shareholders (e.g., founders, employees, investors).

Examine the equity grants and their associated vesting schedules. This involves a thorough review of the following elements:

Grant Details: Ensure each equity grant is recorded accurately, including the type of security (e.g., common stock, preferred stock, options).
Grant Dates: Confirm that the grant dates are correct and correspond with the company’s records and any relevant board approvals.
Number of Shares or Options: Verify the number of shares or options granted to each individual.
Vesting Schedules: Check the vesting schedules for each grant to ensure they align with the terms specified in the grant agreements. Pay attention to cliff periods, vesting intervals, and acceleration clauses.

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Step 2: Validate Transactions

Review all recorded transactions in your cap table. These include equity issuances, transfers, conversions, and cancellations.
Gather source documents like share certificates, transfer agreements, and board resolutions to verify each transaction.
Use Pulley's transaction history feature to get a comprehensive view of all past transactions. This helps you to quickly identify any anomalies or missing entries.
Ensure that the dates of each transaction are correctly recorded. Double-check the number of shares involved in each transaction against your source documents.
Confirm that the details of the parties involved in each transaction are accurate. This includes ensuring that shareholder names and contact information match the records.
Ensure that the recorded transactions are consistent with your company’s equity history. For example, if there was a stock split, verify that all transactions reflect this appropriately.
Ensure that transactions involving different share classes accurately reflect the rights and preferences associated with those classes. This includes checking conversion ratios and dividend rights.
For new equity issuances, verify that board approvals and necessary filings (e.g., with the Securities and Exchange Commission) are in place and match the issuance details.
Check that option exercises and share conversions are correctly processed. Ensure that exercised options are reflected as issued shares and that the corresponding reduction in available options is accurate.
Compare the equity transactions recorded in Pulley with your company’s financial statements. Ensure that the total equity reported in financial records matches the cap table.
If applicable, reconcile cash transactions related to equity events (such as option exercises and share purchases) with bank statements to ensure completeness and accuracy.
If you identify any discrepancies, document them meticulously. Note the nature of the discrepancy, the parties involved, and any potential reasons for the error.
Develop a plan to resolve discrepancies. This may involve correcting entries in Pulley, updating source documents, or seeking clarification from stakeholders.
Use Pulley's built-in error detection features. Pulley can automatically flag potential issues such as missing or inconsistent data, which streamlines the validation process.
Use Pulley's audit trail functionality to track changes and updates to transactions. This ensures transparency and provides a historical record of all modifications.

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Step 3: Confirm Share Classes and Authorizations

Go to the "Securities" section to see an overview of all share classes.
Check the details for each share class, including:

Class Name: Ensure the class names (e.g., Common Stock, Preferred Stock) are accurately labeled.
Rights and Preferences: Confirm that the rights (e.g., voting rights, dividend preferences) associated with each class are correctly documented.
Conversion Rights: Review any conversion rights or conditions that apply to the shares, ensuring they align with the terms specified in the legal documents.

Cross-check the number of authorized shares for each class against the company’s charter documents.
Verify the "Authorized Shares" field for each share class to ensure it matches the authorized amount in your legal records.
Confirm the total number of issued shares for each class. This information can be found under each share class in Pulley.
Review the history of share issuances to ensure all transactions are accounted for and correctly recorded. This includes checking any stock splits, conversions, or repurchases.
Ensure that all issuances and authorizations have the necessary board approvals.
If any discrepancies are found during the review, investigate, adjust records, and communicate the changes made.

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Step 4: Audit Option Pools and Warrants

Review the total size of your option pool. This should be clearly stated in your cap table. Verify that the current pool size matches the authorized amount set by the board of directors or as specified in your company's governing documents.
Audit each option grants to confirm they are accurately reflected in the cap table.
Ensure all exercised options are accurately recorded in the cap table:

Exercise Notices: Review exercise notices and check that the number of shares issued upon exercise matches what is recorded in Pulley.
Update Shareholder Records: Confirm that the exercising option holder's shareholder records have been updated to reflect the new share ownership.

Audit warrants, like options, to ensure they are accurately tracked and managed:

Review Warrant Terms: Examine each warrant agreement to verify the number of warrants issued, the exercise price, and the expiration date.
Track Exercise Events: Ensure any exercised warrants have been recorded correctly, updating the shareholder's equity position accordingly.

Reconcile the option pool and warrant information with the overall cap table to ensure consistency.
Use Pulley features to streamline the auditing process of option pools and warrants. These tools include:

Automation: Track and manage vesting schedules, exercises, and warrant conversions, reducing the risk of human error.
Reporting: Generate detailed reports on the status of your option pool and warrant agreements to identify any discrepancies quickly.
Alerts: Get alerts for upcoming vesting events, warrant expirations, and other important dates, ensuring timely actions and updates.

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Step 5: Reconcile with Financial Records

Collect all relevant financial documents. These usually include balance sheets, income statements, cash flow statements, and general ledger reports. Ensure these documents are up-to-date and cover the same periods as the cap table data you are auditing.
Review each equity transaction recorded in your cap table and cross-reference it with the corresponding entries in your financial records. Pay attention to:

Issuances: Verify that each issuance of shares is accurately reflected in your financial statements. Confirm the issuance dates, number of shares, and the capital raised.
Transfers: Ensure that any transfer of shares between shareholders is recorded correctly in both the cap table and financial records.
Conversions: Check that any conversion of convertible notes or preferred shares into common stock is documented accurately.
Cancellations and Buybacks: Confirm that any cancellations or buybacks of shares are appropriately recorded, including the impact on your cash flow and equity accounts.

Ensure that the total number of authorized and issued shares for each class (common, preferred, etc.) in your cap table matches the figures reported in your financial statements.
Reconcile option pools and warrants:

Option Grants: Verify that all stock options granted are recorded in both the cap table and the financial records. Confirm the grant dates, number of options, and exercise prices.
Warrant Agreements: Ensure that all issued warrants are accounted for, and cross-check their terms and conditions with the financial entries.

Verify that equity compensation expenses match the equity compensation records in your cap table.

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Wrapping Up

As a startup, conducting cap table audits with Carta and Pulley ensures the accuracy and reliability of your company's equity records. By following the steps in this SOP, you can maintain a clear and precise cap table.

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Both Carta and Pulley have features to streamline the audit process, reduce errors, and save time.

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Make cap table audits a regular part of your startup’s financial routine. Apart from ensuring compliance and accuracy, regular audits also enhance transparency with investors and stakeholders.

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FAQs

What is pulley cap table management?

Pulley is a cap table management platform that assists startups in modeling their fundraising rounds, issuing fundraising documents such as SAFEs, and managing wire transfers.

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What is the purpose of the cap table?

The purpose of a cap table is to track the financial interests of the stakeholders of a company. It helps you efficiently organize and manage business ownership and calculate equity splits for future financing.

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What does a cap table tell you?

A cap table shows the ownership structure of your company. Each entry usually includes:

A shareholder's name
Their ownership percentage
The number of shares that percentage represents
The value per share, and
The total value of their holdings.

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