Most Expensive Cap Table Mistakes
4 cap table issues that will blow up fundraising, M&A, or IPO diligence.
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The Most Common Cap Table Issues
A few years ago, I was working with a company that had the worst cap table issues I had ever seen. It was bad… If I was the CFO while these issues happened, I would have changed my name and moved out of the country.
The one positive from this experience, though, is that I learned A LOT about these cap table issues (thanks to some very expensive lawyers), how and what issues can be fixed, and how you might remediate them with your employees.
If you have any ownership over the cap table (CFO, accounting, legal, HR, etc), then please read this post and/or share it with your teams that do. It’s also helpful for regular employees to understand how this stuff works too in case it happens to you.
Mistake #1: Unapproved Grants
An admin error causes grants to not get included on the list that the board of directors approves:
HR fails to tell finance/legal (or whoever owns the grant list) about promotion grants
There is a timing cutoff error on new hire grants so a group of new hire grants don’t make it on any approval list
A founder promises equity but forgets to formalize and communicate with HR.
Someone forgets to actually add it to the board meeting agenda so the batch of grants never gets approved (everyone just thinks it got approved)
What’s Wrong:
No board approval = no grant.
Offer letters always say something to the effect of “contingent on board approval” with respect to the equity listed in offer letters. This is because typically only the board of directors can approve equity grants.
I have even seen cases where the equity admin thinks the board approved the grant since the board meeting happened, stock option agreements are created, and then sent out and signed by employees….but the board never approved the grant so it still isn’t a legitimate grant. And the employee would have no way of knowing that the company screwed up on the paperwork.
The Fix:
For most equity-related issues, waiting to fix it will only compound the problem.
How much higher is the 409A fair market value (FMV)? Companies can only grant at (or above) the current FMV so if your company has gotten more valuable, granting the same number of stock options means the employee will be worse off since there is a higher strike price to buy the stock options. This is less of an issue with RSUs.
Have they exercised an invalid grant? If the issue has gone unfixed for long enough, then some invalid grants may have already been exercised…This makes it much more painful. This is harder to unwind because you have to fix the cap table, refund exercise prices and figure out what to do with any taxes that were paid (AMT, payroll, etc)
Are they still employees? Now this is where it gets really painful. “Hey John, remember how you exercised $50K worth of stock options last year? Well, funny story….those shares you think you own aren’t real.” Former employees are never as kind to you as the current ones. Also, once someone leaves the company, there are a lot fewer options to remediate the problem.
There are a few imperfect fixes for unapproved grants:
Re-grant at current FMV. But like I said, if the valuation increased, the employee gets shortchanged. If the 409A decreased then I guess it works out. Slightly bittersweet that the company valuation is decreasing though.
Top-up grants. Give more options to make the math work. The employee might be happy, but more stock options at a higher price is only good if they expect the price to increase even more than the spread they lost between what the FMV price should have been at versus what they got it at. The company/board is unhappy though because this means more dilution.
Restricted Stock Awards (RSAs). Can help patch past mistakes, but come with tax consequences that can also create problems for employees that may also need to be solved.
Cash bonus / settlement: Give some cash to make up for potential tax consequences and/or change in FMV. This is the main fix if they are now an ex-employee that exercised their “options” that don’t actually exist.
Advisory role workaround for ex-employees. If the employee already left, you can hire them as a contractor/advisor so that you can issue equity to them as a “service provider.” There is some risk here since they should actually be providing some kind of advisory services, which is why this is usually reserved for large grants given to VPs or above.
Return exercise price. If an employee exercised an invalid grant, then you have to return the exercise price and you also have to decide what you will do about any taxes they paid (AMT or payroll taxes on NSOs). You might also be able to do a W-2c if it was within the past three years, but that is always painful so a settlement payout is often easier.
The only potential “get out of jail free” card is if the invalid grant was issued to an employee that has left and never exercised their stock options. For those, you may have dodged a bullet…
Mistake #2: The Stale 409A Valuation
Private companies must get a new 409A valuation at least every 12 months or following any material business changes (most commonly a financing round).
Forgot it’s been 12 months since the last 409A was effective and granted equity.
Financing term sheet is received, but deal isn’t closed. The date the term sheet is received likely invalidates the prior 409A
💡Common mistake: 409As are valid 12 months from the 409A report effective date. Not the 409A report date…. The 409A might be effective on 5/1/25 but your 409A advisor finishes the report on 7/1/25. It expires on 5/1/26 (12 months from effective date)
What’s Wrong:
If a stock option strike price is granted below FMV (regardless of whether its an ISO or NSO), it’s subject to Section 409A, which is a bad thing... There are lots of taxes and penalties for employees if this happens, including losing the ISO status if it was granted as one. It is NOT something you would ever want to do intentionally. It’s a nightmare for both the employee and employer.
The Fix:
Stale 409As are different from unapproved grants. Unapproved grants never actually existed. These grants might exist but they are wrong (and create tax issues). Here is what the fix may look like.
Cancel or deem invalid:
Cancel and “deem invalid” is kind of the same thing, but deeming it invalid is cleaner I think. Basically all stock option plans say that grants must be done at (or above) FMV. So a company can just say the grants didn’t follow the plan so they weren’t properly granted and therefore don’t actually exist. If you “cancel” them then you are kind of saying they were valid, which may mean there should have been tax consequences for below FMV grants.
Get a new 409A:
You probably need to update your 409A. While you may deem the grants invalid under the stale 409A, you still may have a problem with valid exercises that happened under a stale 409A…Exercises have tax consequences depending on the FMV at the time of exercise so if the 409A was stale at the time of exercise then that is a problem for them as well which may require adjustments for tax purposes.
Make employees whole:
Since the grant doesn’t exist the company now has to do one of the make-whole options that I mentioned previously (re-grant at current price, add more options to make up for the increase in FMV, cash bonus/settlement, etc)
Don’t forget to refresh your 409A. The two key times are: 1) at least every 12 months and 2) after a financing. But also understand at what point the 409A goes stale and you must stop any new grant approvals (receiving a financing term sheet, getting an acquisition LOI, etc)
Mistake #3: The Zombie Exercise
This happens at lots of companies… Most stock option agreements have a 3-month post-termination exercise period (“PTEP”). This means that once an employee terminates they have 3 months to exercise their option. Otherwise, the stock option expires.
Here is what usually happens:
Someone forgets to enter the termination date into the equity management tool
Three-month window never starts in the system
Employee checks 6 months later and decides to exercise because it’s still available in the system
💡PTEP vs ISO Status: A lot of people incorrectly believe that stock option PTEPs must be three months or less for stock options to get the favorable ISO status. That’s not true. You can grant stock options with a 6-year PTEP and still have ISO status.
The rule is that stock options just have to be exercised within three months to get ISO status. If someone exercises after 100 days post-termination then the stock options just automatically flip to NSOs.
Having worked at a company that granted long PTEPs, this can be an awesome benefit that employees love, but…it 1) adds a lot of administrative burden and 2) it can add a lot of dilution overhang which obviously means everyone’s slice of the pie shrinks (~50%+ of people don’t exercise stock options when they leave, but if you have a long PTEP then they don’t have to).
What’s Wrong:
If the plan says the option is expired, then it can’t be exercised (regardless of what the system says). The employee thought they owned shares when they exercised, but they legally own nothing.
The company just owes the employee their money back…
The issue may have been caused by a company admin mistake, but the stock option plan is clear, which the employee signed, so the company isn’t typically obligated to do anything (but perhaps legally questionable if the exercise was accepted by the company).
The Fix:
This is different than the first two mistakes because it is kind of the employee’s fault no matter what. They signed an agreement that they only had so much time to exercise options after terminating. An admin mistake doesn’t change that.
Most frequently I just see the company refund their exercise price and undo the “shares” in the system.
But some companies feel bad and try to do something (cash settlement, advisor agreement to regrant shares, etc).
Mistake #4: Waiting to Fix Cap Table Issues
For some issues, it doesn’t matter if you wait to clean them up. Cap table-related issues are not one of those…The longer you wait, the worse (and more expensive) they usually get.
And cap table issues always surface at the most inconvenient moments:
During M&A diligence because potential acquirers are poking holes in everything.
During financing diligence when VCs are making sure they understand who owns what.
During IPO prep while legal is validating ownership before going public
When an employee asks some questions and someone actually digs into the details.
Don’t wait. Make sure your cap table is clean now. If it isn’t, spend the time cleaning up the issues now. It will only get more expensive, the longer you wait. I have seen some big purchase price adjustments in acquisitions because of issues discovered here…
The Cap Table Checklist
Here are the additional checklist items you need to implement so your cap table doesn’t delay/kill a fundraising round, an acquisition, or an IPO. It will also save you lots of money on legal cleanup fees and embarrassment with your board...
Board Approvals or Bust: No approval, no grant. Make sure you have a good process for double-checking the grants that should get included (HR, finance, legal, and CEO final review). I use AI now for this…”Claude, compare approved grants from board meeting to pending grant list to new grants in Carta.”
Fresh Valuations: Set calendar reminders on month 10 or 11 to email your 409A advisors to kick off the process. And make sure that your finance leader who is in the know about fundraising and M&A knows the rules around 409A valuation timing.
Expiration Tracking: Two things I do for this, 1) get a good admin to set a regular cadence for updating the equity admin tool for terms and 2) monthly/quarterly reconcile all terms per HRIS with all terms in the equity tool.
Good Equity Admin Tool – this will make your life a lot easier.
Monthly/Quarterly Reconciliation – Reconcile the cap table with board minutes and HR records. “We have a new hire from 6 months ago that hasn’t received a grant yet”
83(b) Tracking for Early Exercises / Restricted Stock: Something that always comes up in diligence is if proper 83(b) tracking has been performed. Yes, it’s the employee’s responsibility, but companies should keep a record of the filing too in order to avoid issues with the employee and potential liabilities.
Track Early Exercise Terminations: I have also seen companies just forget about folks who early exercised options and then leave before their full vesting period. If the company doesn’t repurchase those shares then they may forfeit their right to repurchase them and then the employee gets to keep the shares even though they didn’t vest.
Track Stock Option Pool: I show the remaining pool and 12-month grant forecast to the board every time we get new grants approved. It’s easy to add and keeps everyone aligned on dilution and the remaining pool available.
ISO vs NSO Classification: Make sure your admin and equity tool handles ISO/NSO rules correctly. For example, contractors/advisors can’t receive ISOs, large grants can run into ISO limits, and post-termination exercise periods can change the tax treatment. Get this wrong and the company will report and pay the wrong amount of taxes.
Rule 701 Tracking: If you don’t track this and apply exemptions when appropriate (like Reg D or 4(a)(2)) then you can accidentally cause a ton of work and broader disclosures of financials…Make sure your legal firm (or someone) is tracking this.
Final Thoughts
A poorly run cap table will cost you lots of money in legal fees, embarrassment with the CEO and board, piss off a lot of employees, and waste a lot of time for many people.
Lawyers can paper some mistakes away (“Section 204” has saved me from a few embarrassments), but a lot of equity mistakes are not easily fixed and cost a lot of money.
Make sure your cap table is clean now before you are in diligence of some kind and it pops up at the worst possible time. These things take time to fix…
Footnotes:
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*Nothing in this article constitutes legal, tax, or investment advice. I am not a lawyer or tax accountant. The above article is based on my personal experience and actions that I have seen performed. Consult with your legal team on what to do based on your circumstances…
