In today’s Finshots, we tell you about why US-based Carta, a startup that helps other startups manage their shares, has landed in controversy.
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Private companies issue shares — to the founders, employees, and their investors.
But tracking and managing these transactions could be a cumbersome process. That’s because shares are issued at various points in time and can come with different clauses attached to them. For instance, shares issued to employees can come with restrictions saying that an employee has to spend 12 months in the company before getting a portion of the shares. Then a new tranche will be issued to them every 6 months and so on. Shares issued to investors might have their own lock-ins and optionality attached to it.
So yeah, managing all this could be quite a headache for a startup that just wants to put its head down and grow.
That’s when a company called Carta came in. It told startups that it would do all this dirty work and help manage their capitalization table (cap table). It’ll create a nifty dashboard to track all the owners of the shares and ensure that those restrictions are clear cut too. And startups could rest easy knowing that these operations were taken care of smoothly. Everything would be digital and Carta would only charge a subscription fee. Think of it as a software-as-a-service (SaaS) firm.
Initially, it wasn’t easy to convince startups to part with this cap table data since this sort of ownership information is quite sensitive. Some investors don’t like others to know where they’ve parked their money. Others don’t want information about the price at which they bought shares being made public. There could be lots of such reasons.
So Carta needed a way to establish credibility.
Instead of approaching companies directly, it decided to approach investors. Carta was in fundraising mode too and during its own meetings, it would pitch to investors by asking them to try the product. The investor would speak to startups they’d put money in, and voila — entry secured.
The idea soon became a hit and startups flocked to sign up. And within a few short years, 40,000 startups used Carta.
But, Carta had realized something else too. There was an even more lucrative business in the private start-up space. Being a broker!
Everyone wants a piece of the next big startup. How often do we hear stories of how early-stage employees of say companies like Flipkart and Paytm have become crorepatis, right? And we can’t all become employees in these companies at an early stage. So most people would do anything to get their hands on these shares.
Hell, we are sure that people would sign up to buy shares of Finshots/Ditto Insurance too ;)
But trading in private shares is hard. You can’t just go to a brokerage and place a buy or sell order. You need to know someone who already owns shares and is willing to part with them. So Carta decided to set up a brokerage to facilitate these sorts of trades. In return for connecting people, Carta would charge a hefty commission on these million-dollar trades.
But hold on…we smell a conflict of interest here.
On one side you have startups that give exclusive access to Carta to their confidential captable. Which Carta charges them for, mind you. And then, Carta turns around and finds buyers for these very same investors whose information they were supposed to keep private?
Yeah, that doesn’t seem cool.
And it’s this conflict of interest which has come back to haunt Carta now.
Earlier this week, Karri Saarinen, the CEO of software startup Linear, took to X (or Twitter) to blame Carta for a breach of trust. He said that someone from Carta’s brokerage reached out to one of Linear’s angel investors. Now this investor was a private family member that the world didn’t know about. And Carta said they had someone who wanted to buy his shares.
Now the folks at Carta’s brokerage business shouldn’t have access to captable information. They’re supposed to be two mutually exclusive businesses. They should run independently. But it appears that wasn’t the case. Because as per Saarinen, this wasn’t an isolated incident. He says 10 other startups told him this kind of unethical outreach happened with them too.
And that was the proverbial straw that broke the camel’s back. Because why would anyone trust Carta with their captable again? Who knows how their data was being used!
We don’t know if this was some employee who saw the opportunity to make a quick buck by indulging in some dubious scheme. Or whether the ‘commission’, if such a trade had been executed would’ve gone to Carta itself. Carta has said it was an isolated incident.
But still, Carta had to do something quickly to save its reputation.
So, it did the unthinkable.
In a blog post, Carta’s CEO said,
…even if we do everything perfectly and make zero mistakes, perhaps just the appearance of being in the liquidity [brokerage] business makes us seem compromised. Everything we do must be grounded in trust and if being in the liquidity business compromises that trust, perhaps we need to reevaluate that offering.
And next thing you know, they decided to shut down the brokerage business.
On the face of it, this shouldn’t have a big impact on Carta. This division generated just $3 million in revenues compared to $250 million from its captable business. So it’s not a huge loss if you consider just money.
But the problem seems to be that Carta’s $8 billion valuation hinged a great deal on its brokerage business scaling up. So investors will begin to question how much Carta is really worth. But also, the bigger problem is whether other startups will forgive Carta for this breach of trust — even if it’s a case of a single employee going rogue. If they don’t, it could be doomsday for the startup itself.
We’ll have to wait and see how this unravels.