The latest controversy around Carta, the equity management software company, has been a soap opera. There is excellent coverage from Dan Primack on Axios here and here. After summarizing the breathtaking timeline, I provide a few observations:
Most of you are familiar with Carta. It’s a great story of a company evolving from one product into an ecosystem platform. Carta began by digitizing paper stock certificates and providing cap table management software. From there, the company moved to 409A valuations. Then, Carta started serving venture capitalists with fund administration software and PE firms with financial reporting. The company now has products for private companies, employees (e.g., 83b election forms), and funders. A proper ecosystem platform in a large, opaque market.
Carta also tried designing products to provide liquidity to private company shareholders (e.g., auctions, investor matching, secondary trading, and open tender offers). It’s this last business that caused the recent controversy.
According to the CEO, the cap table business is about $250 million in revenue, fund administration (venture capital firms) is about $100M, private equity firms represent about $20 million in revenue, and secondary trading is about $3 million in revenue.
Timeline of the Carta Debacle
January 5, 2024
On X (fka Twitter), the CEO of Linear (a private company that uses Carta to manage its cap table) posts evidence that a Carta employee reached out to Linear’s shareholders to offer to buy their shares on behalf of a buyer Carta had found.
The Linear CEO notes this would be okay with Linear’s approval, but this approval was not sought. The solicitation is probably a breach of Carta’s data policy (or should be) and, if not, still seems improper or unethical. It’s possible that the data on who the shareholders are came from public sources, but this would be hard to prove and still does not address the issue of company pre-approval.
On the same day, additional Carta customers reported having the same experience of their shareholders being contacted by Carta without approval.
Also, on January 5, the Carta team (not the CEO?) contacts the Linear CEO to “arrange a call.”
January 6, 2024
The Carta CEO replies to the Linear CEO (on X) that he is appalled this happened and blames a rogue employee. The Linear CEO responds that it looks like more than a rogue employee, given the duration of the issue, and that several Carta customers are reporting the same issue.
The Carta CEO clarifies that he has tried to reach out to the Linear CEO and does not appreciate the Linear CEO airing his grievances publicly (not a Festivus fan, apparently). A pissing match ensues.
January 8, 2024
The CEO of Carta posts a statement on how Carta handles cap table information to Medium. The statement is pretty good and clarifies the circumstances under which cap table data can be used. The use cases are straightforward: anonymized and aggregated use, for internal support, and for marketing directly to customers and users–with company approval. The Carta CEO asserts this case violated internal policy, as no company approval was sought. However, how the employee accessed the information that any decent compliance process would detect or prevent is not clarified. He also raises the rather obvious issue that:
“even if we do everything perfectly and make zero mistakes, perhaps just the appearance of being in the liquidity 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.
I will think about this and come back with more thoughts in the coming months.”
January 9, 2024
The CEO of Carta decides to get out of the secondary trading business. It did not take months to think about, just a day!
Bad PR and Internal Controls?
The CEO of Carta is rightly being criticized for his handling of this issue. (It’s not the first time.) His rogue employee explanation is either true, and Carta has terrible controls, or untrue, and the situation worsens. And from the start, he made the issue too much about himself and the potential harm the public shaming could do Carta.
CEOs Dueling in Public Becoming Common?
Should the CEO of Linear have gone public with his complaint before contacting the CEO of Carta? I probably would have contacted the CEO of Carta first if I had been CEO of Linear. But that is not the egregious issue involved. Everybody posts everything these days, so deal with it. Also, there’s evidence that Carta had been approached before, and the activity persisted.
Look at the speed of the whole thing. The cliche says it takes years to build trust and only a moment to destroy it. In this case, getting Carta out of this business took a weekend.
According to the Linear CEO, the proposed take rate on the private stock transaction contemplated by Carta’s liquidity team was 2% from both the buyer and the seller. (That’s neither here nor there, but I hoard information on take rates!) As the CEO of Linear noted, the transaction Carta was trying to peddle was for $2.5 million. As a result, Carta would have netted $100k or 10x what Linear pays as a subscription for cap table software, so he could “see the temptation.”
Mixing Business Models is Dangerous
Marketplace businesses can sell transactional data, but systems of record businesses rarely become marketplaces. Many marketplaces sell or provide data to their participants (e.g., eBay, NYSE, Nasdaq, ACV Auctions, Freightos, DAT, MarketAxess). The data helps the marketplace function, and as long as the traders know their anonymized transaction data will be used, it is accepted.
Carta is a company touting its system of record for equity ownership, and system of record companies have to be very careful about selling or using data. (Salesforce does not sell your customer data, and SAP does not sell your financial data.) The language the company used around being careful with the data made sense, but did the practices match the language? It remains murky.
(As a side note, most great data businesses (e.g., Zoominfo, Enverus, Verisk, D&B, Moody’s, Nielsen, etc.) also resist the temptation to become marketplaces.)
Conflicts of Interest
Lawyers will wrestle over whether Carta’s terms of service allowed this activity. Customers will question how and if the liquidity business was separated from the cap table business (remember when people used the term “Chinese wall?”). But when my wife worked for the White House, she taught me that what matters when engaging in an activity is not only if there is an actual conflict of interest but also if there is a perceived one. (The same is true of judges; they are supposed to recuse themselves not only when they have a conflict of interest but also when “their impartiality might reasonably be questioned.” (Clarence Thomas?)
Carta could have avoided this problem with clarity, opt-in and opt-out procedures, etc.. But without any of this defense (and some evidence of questionable intent), the appearance of a conflict was too great.