Two Step's Private Company Equity Management Blog

OK. We can all agree that organizing your files is no fun. In fact, if it doesn’t affect your work, you might want to put it off as long as possible (like cleaning your closet, flossing your teeth, or losing 5 pounds). But if you’ve already determined that getting organized is essential to your success, how do you take that first step - especially when there’s really no end in sight?

The lawyers who use Corporate Focus have not only taken the first step; many now have every minute book document and stock ledger record fully organized in a centralized system - and it’s paying off in greater productivity, better client service and fewer headaches.

If you didn’t spring to action when you heard it was National Organize Your Files Week, let me take this opportunity to give you a little nudge in the right direction. Whether you think of it as the first of 12 steps to recovery - or just choosing an apple instead of chips - here are three simple things a corporate paralegal can do that will start you on the path toward having your minute books and ownership records meticulously organized.

Organize Your Way to Better Productivity - Step 1

Warning: Any one of the following activities may cause you to be more efficient and effective in your legal work.

1) Inventory Your Minute Books: Use a spreadsheet and make a list of the name of every company for which your firm has the minute book. List the name, the date you located it, its location, and who is the primary contact at your firm for the minute book. Also, note (for Item 2 below) whether the stock ledger records are kept in the minute book or kept separate.

Tip: If that seems overwhelming, try to make a list of just 25 minute books. Now that you have the process, another 50. Then, another 50...you get the idea. 2) Inventory Your Stock Ledgers: Same process as above, but this time, make a list of the stock ledgers for each company where the stock ledger records are kept separate from the minute book.

2) Inventory Your Stock Ledgers: Same process as above, but this time, make a list of the stock ledgers for each company where the stock ledger records are kept separate from the minute book.

Tip: Keep in mind that you need to know where a ledger is and who is responsible for it, since you will need to look through the stock ledgers later on and fill in gaps.

3) Inventory Your Capitalization Tables: Same process as above, but this time, make a list of those companies for which your firm maintains a capitalization table in a spreadsheet file. This may be a small percent of those companies for which you have the minute book or stock ledger. Only those companies with more complex ownership records or different classes of stock or options will typically have a cap table.

Once you’ve completed these small tasks, let us at Two Step Software know when you’re ready for Step 2. Getting organized might seem challenging, but it’s just a matter of taking it one step at a time.

Imagine what you might get done before July 4th, when we’re encouraging everyone to stop organizing their files for the entire summer. And how great would it be if you could be more productive, organized and effective when you get back to the office after Labor Day. Before you know it, you’ll be ready to transition to an online system like Corporate Focus. Once you do, you’ll be spending National Organize Your Files Week on vacation.

Watch the Corporate Focus video to learn what it would be like to have all your entity, ownership, minute book and compliance information and documents in a centralized, online repository.

My knee-jerk response to this question is an emphatic "yes."

This year marks my 10th year at Two Step Software, and it's amazing to see how legal software products - including our own product, Corporate Focus - have evolved during this period. Let's take a quick look back at a few of our technology milestones over the past decade.

• 2000 - Corporate Focus transitions to a new version of the Windows Microsoft Access database system (Version 2.5 to 97). Law firms are still using Word Perfect - remember that dinosaur?
• 2001 - Corporate Focus is released in another Windows version (Access 2000).
• 2002 - Corporate Focus adds a more powerful database back-end, SQL 2000, and Two Step releases its first Web browser front-end, Corporate Focus Connect. Our law firm clients who adopted this release were able to give read-only access to their clients, although the system was still a client-server model.
• 2005 - Corporate Focus is released as a complete, browser-based system without any Windows or client installations. The system is offered either customer-installed or as a hosted system. Corporate Focus was one of the first legal software applications to be offered as a hosted system. At the time, many firms preferred to manage their own infrastructure: IIS servers, SQL database servers, and firewalls.
• 2008 - Equity Focus is released. It is used by private companies to perform their equity accounting under FAS 123R. The system is only offered as a SaaS model and companies loved it, since they didn't have to install anything.
• 2008 - Corporate Focus is no longer offered as a self-installed application. All new law firms are using the hosted system, delivered from Two Step's world-class hosting facility.

During this time period, Two Step released many upgrades, but only a fraction of our customers were able to keep up with the latest software release. This was largely due to the hard work required of their internal IT departments to upgrade all of their machines.

Jump to 2010, and the software applications landscape has forever changed. When I look around, I see companies like FirmEx, NetDocuments, Rocket Matter, and a host of others all offering legal "software-as-a-service." This doesn't even include all the cloud systems we use every day, like Facebook, Twitter, Google Apps, Salesforce.com, and many more.

All that said, I believe that a point has been reached where SaaS, hosted applications have become the gold standard. The advantages of using hosted systems are crystal-clear, the highlights being that a) internal IT departments, particularly in the recent downturn, don't have to waste precious resources on software upgrades, b) users are always in the most recent software releases, and c) IT infrastructure budgets can be drastically reduced. Plus, if law firm clients are confident with using SaaS and cloud-based applications for their own data, why shouldn't their law firms be comfortable with it as well? At Two Step Software we see our law firm customers, both new and existing, using our SaaS offering not only because it saves them money every day, but also because it's faster and more secure in most cases.

So should law firms still check out their vendors carefully? Of course they should. SLAs should be checked, questions should be asked, and data confidentiality should be strictly enforced by both the customer and the vendor. But, that's also true if the data is hosted internally.

No one can tell what tomorrow will bring. Will everyone use touchscreen computers (à la the iPad)? Will everything be in the cloud and individual servers be obsolete? Will we all be touching some interface in thin air (à la Minority Report)? I certainly don't know.

What I do know is that in 2020, Corporate Focus will still be here. Lawyers, stock plan administrators, and other legal professionals will be printing stock certificates, generating capitalization tables, and doing whatever other work their clients need done faster and more self-sufficiently than ever before. In 2020, we'll all look back on the "old days" and say, "I remember SaaS and the cloud..."

Alas, the future is...well, it's in the future. If you would like to see how Corporate Focus can work for you today, sign up to see a demo.

And of course, please feel free to add a comment about this post; all thoughts are welcome.

I was at a law firm the other day listening to three attorneys debate whether their spreadsheets were a satisfactory tool for doing their transactional clients' capitalization tables. The first attorney (we'll call her Susan) said that her spreadsheets were fine. Her stock plan administration worksheets rolled up automatically into a few other worksheets for a client's capitalization tables and those worksheets could show the data by class, type, date, and fully-diluted.

It all sounded very complicated, but I was impressed. The next attorney (we'll call her Ann) said that her spreadsheets could track the stock and option data, but could not display it by date in the past or in the future. Also, her spreadsheets could not handle option vesting schedules. The third attorney (“Eric”) asked if Ann used the same spreadsheet templates as Susan. Ann said that her spreadsheets were similar to Susan's, but with some variations. Eric admitted that he’s basically a spreadsheet novice.

The reason we were discussing capitalization tables is that they are critical decision-making tools for CFOs, investors, board members, attorneys and clients – and they need to be 100% accurate. Anything less is bound to make someone look very bad. Sometimes the problem is as simple as two people with two different versions of the same stock issuance or option grant data.

As the innocent bystander in this rousing discussion, I commented that it sounded like everyone was doing the record tracking and corresponding capitalization tables slightly differently. Then I suggested they consider an online, consolidated system for ownership administration – for five pretty compelling reasons:

1. Centralize and Share Data: If data needed for capitalization tables is in one place – rather than in multiple copies of spreadsheets – there are fewer discrepancies. Centralized online data can also be shared more easily.
2. Simplify Data Entry: Data can be entered more accurately if all you have to think about is point-and-click. It means less typing and no tedious copying and pasting.
3. Automate Calculations and Reports: A computer-based system will never make a mistake, no matter how difficult the calculation.
4. Increase Standardization and Best Practices: If everyone is doing tasks the same way, you have the ability to set best practice standards and ensure consistency enterprise-wide.
5. Connect Data to Documents and Accounting: In a consolidated system, it is much easier to link related stock plan administration data and documents, such as Board minutes to option grants or grant data to complex FAS 123R reporting.

Susan objected only when I mentioned that a centralized system would reduce the risk of errors. She insisted that her capitalization tables were accurate. And while I had no reason to doubt that, I asked whether her spreadsheets could handle changes in the preferred stock conversion ratios, for instance, or a stock split. Susan replied with an emphatic “yes." She explained that she just copied and pasted the new ratio down the entire column and the next cell generated the updated calculation.

I told Susan that this was precisely where errors happen. In fact, I saw a reference recently to a KPMG report that suggested the vast majority of operating spreadsheets used in financial reporting contain material errors – which is consistent with what we hear from CFOs every day. Even when they have not yet encountered problems, these CFOs say that they are ever-fearful that their resident “spreadsheet guru” might leave (and take their ability to use complex and connected spreadsheets with them).

It's not that spreadsheets are bad or can't handle complex calculations. Of course they can. It's just that the standardization and simplification benefits of an online stock plan administration application are overwhelming. This is particularly true when you consider many different people, using many different spreadsheets, to track many different equity transactions, for many different companies that each have complex capital structures. The risk that an error may creep into the process and flow through the entire system is tremendously high. Another benefit of a web-based system is the opportunity to save money by redirecting routine tasks to a lesser-skilled and lower-cost person.

The next time you're working with complicated spreadsheets for your ownership administration and capitalization tables, consider this: What if you could simplify, standardize, and centralize the work while creating a process that costs less and increases accuracy? When you're ready to stop worrying about hidden errors or copying the right numbers into the right cell, take a look at Two Step's Corporate Focus system to find out what an online, consolidated equity management application could do for you. After all, you have far more important things to worry about these days.

As the founder of Two Step Software, I've been asked numerous times how to simplify the many complex aspects of equity management. When we developed our online system 15 years ago, our goal was to use a database application to make the equity management and reporting process easier, faster and more accurate. And as we continue to work with new customers and listen to their challenges, we often come back to the same three-part framework that can be used create a solid foundation for anyone involved in this type of work. The basic framework consists of the following:

1. Capitalization
2. Equity Accounting
3. Compliance and Documentation

Now, let's take a brief look at each of these areas individually.

A. Capitalization

Capitalization means tracking who owns the company and what they each own. The capital structure may consist of many different types of ownership instruments, such as common stock, preferred stock, options, warrants, restricted stock, and convertible notes. Each equity instrument is held by different types of owners, such as founders, management, employees, investors, lenders, and partners.

The three basic components of capitalization tracking are:

1. Stock plan administration: The basic tracking of each type of ownership instrument and who owns it.
2. Equity transactions: Ownership changes occur over time for many reasons such as initial issuances or grants, transfers, vesting, exercises, employee terminations, restrictions lapsing, death, and divorce.
3. Fully-diluted capitalization tables: There are many ways to report the capitalization of a company, but there are a few common formats which generally are based on types of ownership or who the owners are (by person or group). A common way to report the total ownership of a company is to look across all of the different types of ownership and break it down to the simplest level which is known as "common equivalents."

Ownership record tracking is the foundation for accurate equity management. If it’s not 100% correct, any errors or inconsistencies will lead to costly mistakes that will get magnified over time.

B. Equity Accounting

Equity accounting is an exercise to determine what number should be reported for equity compensation expense in the income statement for the period. Until FAS 123R (which came about in Dec. 2004), many venture-backed, non-public companies typically reported no equity compensation expense for stock options granted at fair market value. Under FAS 123R, this is no longer permitted. Now, privately-held companies that report in accordance with GAAP or are being audited must include an equity compensation expense amount, even for ISOs.

The three basic components of equity accounting are (using the example of stock options):

1. Valuation: FAS 123R requires a company to determine the "fair value" of a stock option granted to an employee using an accepted valuation formula such as Black-Scholes. Its variables include: exercise price, FMV, expected term, volatility, risk-free interest rate, and dividend rate.
2. Expense determination: FAS 123R mandates that a company recognize the cost of equity-based compensation over the related "service period" (usually the vesting period). It also requires the use of an expected forfeiture rate and periodic "true-ups" to account for the fact that a portion of options may never vest.
3. Financial statement disclosures: Paragraphs 64, 65, and A240 of FAS 123R describe the disclosure objectives and minimum disclosure requirements. Examples of these disclosures include: range of variables used for calculating fair value; weighted-average values for fair value, exercise prices, and remaining term; options exercisable at the end of the period; and unvested options at the end of the period.

C. Compliance and Documentation

Too many companies fail to think about good compliance and documentation in advance. Instead, they wait until someone needs something they can't find—and that’s usually the auditor as the audit is being wrapped up or an attorney doing due diligence for an important transaction.

The three basic components of compliance and documentation are:

1. Legal compliance: Every time equity is given out, it involves a legal process, such as memos to the compensation or option committee, board or committee votes, delivering option grants and stock certificates, and notices to employees. Many of these tasks can be performed by someone in legal or finance, but the process should be established ahead of time and documented with legal sign-off.
2. Legal documentation: On the legal side, you need to track copies of each legal action, legal notice, or agreement. These documents should be tracked in the system that you are using for equity management with documents linked to the corresponding records.
3. Accounting documentation: On the accounting side, your system should be able to track and report how each number was determined and any supporting documents. This could involve reconciliation of options outstanding, exercised or vested; variables used in the Black-Scholes formula; or amounts expensed in each period. When an auditor wants to see the backup detail, it should be easy to pull from the system, avoiding extra effort and wasted time.

Fit the Pieces Together and Save (Time and Money)

To be successful at equity management, you must fit all the pieces of the puzzle together. You can't leave out one piece or ignore its importance. Do it right and you’ll drive down one of the high-cost areas of corporate accounting for any venture-backed company. Equity management and accounting can be expensive and time-consuming since it normally involves costly legal and audit resources.

Optimizing these three aspects of your equity management means bringing all of the information and tracking into a single, consolidated system that the entire team—across finance, legal and audit—can use for their particular requirements. When you do, you can finally get rid of all those complicated spreadsheets and get your work done faster and better than you ever thought possible.

Download our FAS 123R Productivity Kit to find out how to simplify your equity management and FAS 123R reporting.

In his keynote address at the International Legal Technology Association’s 2009 conference, Richard Susskind, one of the leading legal thought futurists and author of the book "The End of Lawyers," presented the simple point that law firm clients "want more for less." The pressure has always been there, but the dismal economy, a broader spectrum of choices, and the greater sophistication of in-house legal departments have all combined to put legal fees under a microscope. Furthermore, legal departments are using fewer outside firms and scrutinizing bills more carefully than they ever did before. 

Susskind explained that in order to provide more value for lower fees without hurting the bottom line, law firms must adopt either a) an "efficiency strategy" or b) a "collaboration strategy."

With an efficiency strategy, law firms work to cut costs by turning certain activities into commodities. With a collaboration strategy, firms share costs and collaborate with clients in more effective ways. Both strategies result in lower fees for standard legal tasks without compromising fees for higher-value work.  The key is to value-price "commodity services" - those that a client can get anywhere - rather than custom services which are unique to a particular firm or attorney. 

A simple example of a service that is ripe for commoditization is a corporate formation. If one firm can form a new real estate LLP entity for $400 and another firm is charging $600—and the work product is presumably the same—then why wouldn’t a client use the lower-cost firm?

The Shift to Greater Efficiency is Already Underway

Listening to Susskind speak, I realized that we have been seeing this phenomenon in action at Two Step Software over the past few years in the area of equity management. Our law firm customers have been using our equity management system, Corporate Focus, to lower the amount of time it takes to track stockholder information, update option vesting schedules, calculate fully-diluted capitalization tables, and print stock certificates. 

No law firm is trying to win business by claiming that it can calculate a capitalization table better than a competitor. It's either right or it’s wrong. When it comes to equity management, the only differentiating factor between law firms is how long the work takes. Many firms have clearly demonstrated that what had once taken them hours to do manually can now be accomplished in minutes using an automated, centralized and standardized system like Corporate Focus. This ends up costing the client less in legal fees and firms can drastically reduce the amount of time that must be written off. For instance, one firm explained that in the past it would have taken all morning to print 75 stock certificates—and now they can do it in less than an hour. Another typical example is the calculation of fully-diluted capitalization tables which takes just minutes when all of the equity data is tracked in a single, consolidated system.   

Other firms have been collaborating with their CFO clients in new ways such as sharing the tasks involved with stock plan administration and equity accounting. This was previously done in two separate systems with lawyers tracking the stock and their CFO clients tracking the employee option grants and exercises. Transferring information or changes back and forth inevitably meant duplicate work, potential errors, and wasted time. Now, clients are granted direct access to a law firm's equity management system or the law firm can be given access to the client's system. The fact that everyone is sharing responsibility for this low-value recordkeeping work saves time and reduces legal fees.

Attorneys using Two Step Software’s equity management system tell us that their clients are impressed with the turnaround time on complex ownership questions. They appreciate being sent copies of documents faster or getting email reminders—not to mention the lower legal bills. Many firms have even told us they can now do the same amount of work with fewer people, which is almost a necessity in this daunting economic climate.

Whether it’s greater efficiency or increased collaboration, these smart service strategies favorably impact a law firm’s bottom line, even when the top line is not growing as fast as it has in the past. And undoubtedly, the most productive firms will also increase their pipeline of work from their best clients. With in-house legal departments and CFOs working with fewer law firms (and being more selective about those they do work with), the firms that make their motto “more for less” will ultimately prevail.

On my way to the International Legal Technology Association's 2009 conference, I read the Wall Street Journal's front-page article, "Billable Hour Under Attack - In Recession, Companies Push Law Firms for Flat-Fee Contracts," with great interest. The initial talk about a change in the ways law firms bill their clients came as the financial markets were on the brink of collapse. Now, almost 12 months later, the evidence shows that there is a real shift taking place-and it may not be as temporary as the current economic downturn.

Some interesting facts from the WSJ article:

• Pfizer will save 15-20% on outside legal fees "largely through flat-fee arrangements"
• Cisco uses fixed fees or other alternatives to the billable hour for about 80% of its legal work
• American Express has not had any firm tell them they would not consider alternatives to the hourly billing model
• $13.1 billion has been spent on alternative billing arrangements so far this year, compared to $8.6 billion in the same period last year (BTI Consulting Group survey)
• Lawyers reported average cost savings of 15% from using alternative billing arrangements (BTI Consulting Group survey)
• 63% of the 370 in-house lawyers surveyed plan to increase their use of alternative billing arrangements (BTI Consulting Group survey)

With this type of compelling data supporting the use of alternative billing arrangements, it's clear that the tide has turned. Whenever appropriate, companies will be asking their outside counsel for billing options that align the interests of clients with those of their counsel. This is in stark contrast to the traditional hourly billing model which favors the law firm at the expense of the client.

Firms are Shifting Their Focus to Productivity

Pfizer's General Counsel, Amy Schulman, articulated the new legal billing mindset, stating that she did not want a discount on hourly fees, but a fundamental change "that will last beyond whatever people think they have to tolerate because of the economy." 

This change is pushing law firms to look for ways to work more efficiently since, unlike the hourly billing model, they will now have an incentive to get more work done in less time. As an example, the WSJ article says that Orrick, Herrington & Sutcliffe in San Francisco has tripled the revenue it generates from alternative billing arrangements "but has maintained profitability through efficiencies," according to their chief client-service officer, David Fries. How do they do it?  Among other things, the firm employs workflow technologies that substantially increase productivity. 

Now, this is not rocket science. Aren't these essentially the same types of productivity enhancements that have become standard practice at most businesses (that aren't working by the hour)? Implementing technologies that help you get your work done faster and better simply makes good business sense.

In working with hundreds of corporate law firms over the past 15 years, we at Two Step Software have seen remarkable productivity improvements in the more routine areas of business law, such as:

• Calculating capitalization tables and managing ownership information
• Searching for minute book records and historical filings
• Creating documents, stock certificates and standard forms
• Tracking compliance information and generating alerts
• Sharing information and documents with clients

One example is our Corporate Focus customer Macfarlane, Ferguson & McMullen which is now "able to complete an organization from start to finish within 30-45 minutes" instead of the time it used to take to complete the process. The attorneys get the documents faster- which means their clients also get them faster, at a lower cost, and with fewer errors. (We've captured more of these examples in our Law Firm Productivity Kit.)

In the end, legal clients will shift more work to firms that offer the greatest value for every dollar billed. There's no going back to the days when hours were not monitored carefully or alternative billing arrangements were not an option. External pressures from increasingly sophisticated clients are shifting the legal landscape in ways that were never even dreamed of five years ago. 

As I spent the past week at the 2009 ILTA annual conference, I spoke with CIOs from leading law firms across the country and discussed ways to improve the levels of efficiency and client service at their firms. Everyone is on the same page now and it's an exciting time to be looking at how technology can help make a profound difference in legal productivity. 

Let me ask you a question: Do you brush your teeth every day? Or just the week before a dental check up? 

Imagine if the only time your teeth were brushed was twice a year at the dentist. It wouldn't be a very pleasant visit (not that they ever are, actually). Well, that's the situation too many law firm clients find themselves in when they’re ready for a corporate event or transaction. Right before a financing or annual meeting, everyone rushes around in a mad dash looking for documents and updating capitalization tables. Why? Because the records haven’t been updated or organized since the last mad dash. 

But if you're a corporate client at Pierce Atwood, LLP in Portland, Maine, the frenzied scene described above is a long-ago memory. I recently sat down with Chris Howard, the head of the firm’s business practice group. He explained to me that with the firm’s centralized client information management system (CIMS), Corporate Focus, the corporate records for all of their business clients are organized, minute book documents scanned, and capitalization tables up-to-date. 

As the largest New England law firm North of Boston, Pierce Atwood has over 1,000 corporate clients who can depend on having their information and documents just one click away when they call. In fact, Chris told me that some of their clients have direct online access to their own information in Corporate Focus on a read-only basis, which eliminates the need for these clients to even contact the firm. This saves the clients legal fees, offers them more flexibility in searching, and of course saves boatloads of time because they can get to their data around the clock. 

As Chris bluntly put it, clients don't usually choose a firm because they practice outstanding “corporate hygiene.” But when an important transaction is pending, these clients notice and appreciate the level of service and risk management that Pierce Atwood provides—whether they need it or not. It's just how the firm does business. And it's the right way to do business.

Chris also noted that it's not really a matter of what technology you have at a law firm, because many firms have implemented state-of-the-art systems and applications in recent years. What’s important is how you use this technology for your clients' benefit. Depending on which client you talk to, those benefits might involve faster turnaround times, lower legal costs, or 24/7 access to legal records. But any way you slice it, when clients see this kind of productivity in action, it doesn’t escape their attention.

In fact, Pierce Atwood’s efforts to help clients help themselves—through a firm-wide CIMS—have enhanced its reputation in the legal marketplace. As Chris explained to me, trust, reputation, and client service are what make a law firm successful—and it’s these qualities that lead to satisfied clients telling other companies about their positive experience. Corporate Focus also makes practicing law easier for Pierce Atwood attorneys, because they can spend more time and energy on legal advice and negotiation and less on administrative requirements. 

Do many law firms use Corporate Focus or have access to systems like Corporate Focus? Of course. Does it take unusual rigor and tenacity to implement a firm-wide client information management system as Pierce Atwood has done? Absolutely. Do their clients appreciate the benefit when they're ready for their next transaction? You bet. Just ask any of them.  

Then ask your corporate practice group: Do you practice corporate hygiene for your clients on a regular basis—or just the week before a major transaction? Ask them which their clients would prefer. Then ask their Board or investors.

Corporations depend on their CFOs to report "the numbers" each period. But what happens when these numbers are based on data that’s being tracked at the company's law firm—instead of internally? 

When a company is initially formed, all of the legal and ownership records tend to be maintained by their law firm because, frankly, it's just easier. Over time, the organization begins to grow, and as it does, the complexity of its capital structure tends to grow as well. For example, as an enterprise gets its first round of angel or venture capital financing, it may issue convertible preferred stock and warrants and adopt an employee stock option plan.

The complexity typically relates to the company's capitalization table, its stock plan administration, and the reporting of equity compensation expense under FAS 123R. Each year or quarter, the CFO must determine—in addition to how much was paid in cash compensation and benefits to the company's employees—how much compensation was paid to employees who have stock options or other equity compensation.

The Current Approach No Longer Makes Sense

Although stock plan administration work can be outsourced by a company to its law firm, the equity compensation reporting normally isn’t, because it involves accounting work. And so, at the end of each year, it has been common practice for paralegals to send reports and spreadsheets to CFO clients who need to calculate their stock option related expense. The CFOs then take the information provided, add it to their own internal spreadsheets, and run the numbers for the period.

The problem? This typical approach has proven to be very difficult, time-consuming, and error-prone. The challenge is that the data is being updated by the law firm while the accounting calculation that uses the data is being done by the company—each in their own separate system or set of spreadsheets. An uncoordinated system and a virtual recipe for disaster.

The Solution? One Consolidated System.

The solution is to bring the stock plan administration being done by the law firm and the equity compensation reporting being done by the CFO together seamlessly in a single, consolidated system. In this way, everyone is using the same set of live data and the information is real-time, accurate, and consistent. No time is wasted sending reports and spreadsheets back and forth while manually updating information that is being tracked and reported by one side or the other.

Here’s how this integrated approach works: At audit time, the CFO logs into the stock plan administration and equity compensation reporting system that has been used by the paralegal at the law firm throughout the year. The CFO knows that all required changes for the year have been updated, since he or she has had access to the information all year and has updated the valuation variables on an ongoing basis. 

To calculate the amount of equity compensation expense for the current period, the CFO simply presses a button or opens a report. Because the same formulas are used consistently throughout the system for every record and across each period for the expense calculation, as well as for the required financial statement disclosures, the CFO can be confident that it is 100% accurate.

Whether the consolidated system is at the law firm, at the client’s office, or somewhere in between is immaterial. What’s important is that everyone is using the same system. All parties can log in and work on the areas that are relevant to them, and everyone can see the data live and report on the information as their needs require. 

A single system for stock plan administration and equity compensation reporting ensures that data is reviewed and kept up-to-date over the course of the reporting period. And because all of the information is already in the system well before the end of the reporting period, it avoids the typical mad rush at audit time. 

Does this sound like a better method? It is. Does it sound too easy to be true? It's not. Many law firms and CFOs are already using this approach—and they're thrilled with the results. What a difference it can make at audit time (not to mention everybody’s stress levels). It's just a matter of working together.

A few days before his inauguration, Barack Obama told John King on CNN: 

 "Here's the good news ... we have a lot of investment in making the health care system more efficient. Just a simple thing like converting from a paper system to electronic medical records for every single person can drastically reduce costs, drastically reduce medical error, make not only health care more affordable, but also improve its quality." 

When I heard this, I imagined for just a moment that he had said "electronic legal records" instead. For years, law firms and medical practices have been slowly migrating their voluminous paper client records to online systems that can be easily searched, tracked and recalled—whether one is searching for the date of incorporation or the last measles shot.

And “slowly” is the key word here.

Historically, administrators and IT personnel have had a heck of a time getting the highest-paid professionals—doctors and lawyers—to use computers or even type prescriptions and client notes. In fact, the age-old joke is that the worse a doctor’s handwriting is, the better the doctor. (My father and two brothers are doctors and I'm a non-practicing attorney, so I know from whence I speak).

About 5 years ago, I noticed that my dog's veterinarian had all of his doggy records entered in a computer system. Every X-ray, shot, cough, bark, and poop sample was recorded and up-to-date. As the proud parents, my wife and I had online access to our pooch's entire medical history. The same was true for my dentist and for my son's pediatrician. None of them could answer a question without consulting the computer in the examination room.

However, my own physician had to flip tediously through a folder when I asked him a question about last year's physical. And when my wife went in for a procedure that required general anesthesia, the doctors were running around looking for the misplaced three-ring binder containing information on her allergies as well as our consent forms. I was shocked that these reputable practices were still stuck in the dinosaur age of client information management.

Sadly, these same examples apply to 90% of the attorneys in the country, despite the fact that unlike doctors or veterinarians, attorneys are charging $400-$1,000 per hour and can well afford to implement a modern electronic records system.

Having worked with hundreds of law firms over the past decade, I've never heard an attorney disagree with President Obama's basic premise that converting from a paper system to electronic records would drastically reduce costs, reduce errors, and improve service quality. For instance, Philip Beck of Bartlit Beck, The American Lawyer Litigation Boutique of the Year Firm, explains their use of technology: "In the office, we have immediate access to whatever information has been stored on the computers, and we can sort it and analyze it instantaneously, without waiting for help from support personnel."

Yet despite the fact that the benefits of an electronic records system are crystal clear—for law firms and their clients—it’s simply not happening in most mainstream practices today.

So what will ultimately entice these firms to make the switch? The transition process itself takes a good amount of time and effort, even if the actual costs are minimal. Will it be the sagging legal market that is crying out for greater efficiency as firms lay off attorneys and staff? Will it be partners watching profits drop or competition for new clients grow? Will it be clients that are demanding lower legal fees and 21^st-century service capabilities, such as self-service portals and 24/7 access to information? 

Imagine the impact on corporate America's legal bills over the next decade if every in-house counsel, CFO and board member for every venture-backed and public company could find all of their minute books, capitalization tables, contracts, due dates, and invoices online—from anywhere, at any time and without paying a single dollar in legal fees.

I'm just asking all the lawyers in America to think about what their doctor friends are about to be mandated to do—and then think about the millions of paper legal records sitting in their offices, growing more cumbersome by the minute.

It may be a challenge for an industry that has typically been a technology laggard, but in the spirit of change, why not practice a can-do attitude when the next technology project is proposed? Think about the positive impact on your bottom line: "Yes We Can." Think about the greater efficiency and productivity: “Yes We Can.” Think about being able to offer exceptional service to your clients in an increasingly competitive legal environment: "Yes We Can."

In our education programs at Two Step Software, we provide basic training for those who do the difficult work of tracking and creating capitalization tables and offer other courses that focus on equity compensation accounting. However, for a change, we thought it would be useful to take one step back and help those who are responsible for basic cap table tracking (but aren’t "deal gurus") understand some of the deal terms that may not relate to cap table tracking at first blush.

While sometimes it’s the tracking that matters most, it’s also critical to understand the terms that relate to the investment side. If you’re responsible for tracking the equity in your company's capitalization table, you should be familiar with this terminology in order to understand how all the pieces fit together. This understanding will serve you well as new stock is being issued—or as more complicated equity instruments become involved, such as preferred stock, stock options, or warrants. 

Once the big numbers are determined -- such as valuation and how much the new investor will get of the company -- the details must be implemented: How many shares is the new investor going to get? How many shares of preferred will be issued for the agreed portion of the common stock? How do they convert? How does the increased option pool fit into the total capitalization? Will the liquidation preference increase over time? How do the investors participate in future rounds?  

I recently came across a set of blog posts from four years ago, written by an early-stage investor, Brad Feld, Managing Director of the Foundry Group and formerly of Mobius Venture Capital. His blog, worth reading, is full of outstanding writing and insightful commentary. Despite their age, these posts provide the equivalent of a half-day seminar on understanding venture capital terms for a stock plan administrator, junior finance department member, young corporate attorney, or corporate paralegal. If you've ever found yourself on a conference call where the discussion sounded like a foreign language, take a few minutes to read these articles. 

The four blog post titles are (click to view): 

“Venture Capital Deal Algebra” discusses the basic concepts of "pre-money" and "post-money" valuation and how to calculate the shares to be issued. Among the information it shares are some very simple formulas that could be extremely helpful for deal novices, such as:

The other three posts are self-explanatory based on their titles. They cover areas that many non-lawyers, non-CFOs and non-venture capitalists don't really understand (and in the sophisticated world of VC and private equity investing, few are bold enough to raise their hand and ask). Judging by the reader comments in these posts, it's also clear that even some investors and founders don't understand the terms completely.

It’s possible that these individuals have avoided the second tier of negotiation that is required to flesh out what a term means under specific circumstances (see: What Does Pro Rata Mean?). For every investor who has done a few deals in the past, it seems like these terms should be obvious based on the way they were used in those unique deals. But as these articles suggest, there are probably many other investors who have used them differently in their own deals.

If you are new to venture capital terms, read these blog posts and you’ll greatly increase the chances that you can actually understand what the terms mean on the Term Sheet and spend a little less time hoping no one asks.