Bass, Berry & Sims attorney Davis Mello authored an article for Venture Capital Journal discussing how to address the challenges presented by “upside-down” capitalization tables in venture-backed companies, which tends to occur when start-ups have significant amounts of capital via convertible securities and/or at valuations that are no longer supportable.
Davis detailed how aggressive valuations in early rounds of capital raising can be contributing factors to creating upside-down cap tables, and how venture capital investors can diagnose, manage and resolve the problem from a legal perspective.
In the article, Davis outlines the five components of common recapitalization strategies:
- Convert and cap legacy SAFEs/notes.
- Restructure or reprice preferred equity.
- Refresh or expand the employee option pool.
- Use clean terms.
- Obtain consents and manage legal approvals.
Davis concluded the article by saying, “Upside-down cap tables are not unsolvable, but they do require early recognition, legal precision and stakeholder alignment. For venture capital investors, proactively addressing these situations – before companies hit the fundraising wall – can unlock latent value, restore team motivation and position the company for future success.”
The full article, “How to Deal with Upside-Down Cap Tables,” was published by Venture Capital Journal on August 19 and is available online.