Cannabis Knowledge & Insights

Cap Table Mistakes That Can Kill Your Cannabis Company (Part 1)

Operators need to know that something as basic as a cap table mistake can kill a cannabis company before it ever goes public. 

When going public, your business will be under extreme scrutiny. And since you’ll be raising money from the public, the deal will need to be underwritten by a trusted bank. The bank will then be responsible for auditing all of your financials, including the cap table. 

This article will review some of the most common mistakes operators make by using inaccurate information around their cap table. An incorrect cap table can cause the inability to receive a finalized audit opinion, preventing you from going public. 

In addition, if your cap table is messy, who will want to invest in your business? A clear-cut cap table provides transparency for investors. They understand who they’re getting involved with and how they previously managed their business. 

Who Manages Your Cap Table?

Typically operators manage their cap table with specialized software and a knowledgeable business professional, such as a CFO. 

If you don’t have a CFO already, it may be time to hire one. Or you can save on their salary by outsourcing a trusted firm, such as GreenGrowth CPAs. Our trained professionals have a deep understanding of the cannabis space. We’ve worked with companies across the US at every stage in their business. For more information on how a CFO can impact your company, check out our YouTube educational videos

Failing to seek professional advice may save you time and some money immediately. Although, the future cost could be incredibly high. 

Why, you ask? 

Because non-compliance with tax filings, inaccurate distributions of profits, and the inability to raise more capital can stop your business growth dead in the water. 

Understanding the Story of the Cap Table

To understand how the cap table works, let’s first look at what the cap table tells the reader. 

Cap tables are more than just percentages on a piece of paper, they are encoded stories of a company’s past.

The composition of equity allocations can explain a lot about what the company can do. It also encompasses the distribution of ownership and who is responsible for making the major company decisions. 

We recommend understanding how specific changes can impact the business from the start of the cannabis business all the way through finalizing your exit. 

Since your business story is constantly evolving, periodically updating the cap table is essential. Typical recommendations include evaluations when there is a new round of financing, additional share options are issued, or while reconciling vesting schedules

One of the most significant mistakes founders make is using spreadsheets to manage their cap table. This causes everything to become disorganized and complicated because of the complex mechanics of how equity positions evolve over time. 

As your company grows and gets funding, spreadsheets do not provide enough support to keep the cap table updated. This is especially important when used by multiple parties at the same time. 

The EXTREME Importance of Data/Record-Keeping 

Yes, managing a cap table may seem tedious, but it is a vital part of the financial operations of the business. In addition, you can make better decisions by understanding the intricacies of equity information. 

For example, a thorough understanding is critical to know what portion of the company is available to give when raising capital from outside investors. You don’t want to give away too much or not have enough to give once negotiations start to move quickly. Also, investors will want to see who has control of the company by way of ownership.

In the case of an audit, a cap table that is periodically maintained helps your legal team accurately review the company history. They can easily identify changes in ownership and quickly provide detailed and accurate advice to clients who keep their information up to date. 

Can compliance issues come from an outdated cap table?

The short answer is yes, and the issues can be extremely painful.

The biggest headache comes from compliance with the IRS and taxes. It hurts the company and can also adversely impact the employees who own shares as well. Getting compliance wrong can cost the founders, shareholders, and even the employees a lot of money.

The two most common compliance issues include:

  • 83(b) election concerns the treatment of restricted stock awards, and it is critical to have it filed within 30 days of the grant. 
  • IRC 409A laws require an independent valuation of a private company’s common stock, which helps determine the cost to purchase a share. (aka the strike price for options)

Aside from these, you also have to worry about Rule 701 and ASC 718.

In regards to cap table maintenance, compliance issues are easily avoidable if you take the steps to work with experienced financial professionals. 

Need help maintaining or reviewing your cap table?

To learn more about reviewing your cap table before going public or raising additional funding, please reach out to our team of financial experts at GreenGrowth CPAs. We are here to help your cannabis venture through any level of the accounting, tax filing, or business cycle. 

We employ several financial programs to assist the company with its fiscal responsibilities, including tax planning and compliance, outsourced CFO support, audit preparation, tax controversy support, and much more.
For recommendations and assistance with tax planning and accounting services, schedule a free consultation or contact us at 1-800-674-9050.