nderstanding all the technicalities of startup investing — how you should calculate your valuation, or what your term sheet actually says — can feel incredibly daunting.
On top of pitching and finding the right investors, understanding all the complicated terms and nuances of startup investing requires learning and applying what is likely completely new information to you. But just because something is new or uncharted territory for you, doesn’t mean it’s impossible to understand.
In this blog, we’re getting back to basics while we break down the concept of cap tables for you so you can better understand what they are, how they’re built, and the important role they play within the startup and VC ecosystems.
What exactly is a cap table?
A scaling business might undergo multiple changes to its equity structure throughout its lifecycle. This could be due to funding rounds, stock issuance, share cancellations, transfers, exercising stock options, and more. Because of this, it’s important to have a living, breathing document that keeps track of all of the company’s shareholders and how much of the company they actually own.
Enter the cap table.
A cap table, or capitalization table, is a live document that not only allows shareholders to keep track of their stake in a startup as it raises more capital or undergoes other changes in its equity structure but also helps investors understand what they’re buying.
In a nutshell, a cap table is an actual table that takes all of the shareholders in your startup and lays out who owns what, how much each one owns, and what value is assigned to the stock they own.
Sounds simple in theory right?
As a company matures, however, the cap table can develop into a much more complicated beast. It also can be a super time-consuming process of updating, monitoring, and regular communications with all stakeholders.
It's critical however that every founder knows how to build and manage a cap table.
Why are cap tables so important?
Okay so hopefully you have a super basic understanding of cap tables and the purpose they serve to both investors and founders. Now, let’s talk a little about why they’re so important!
The truth is, cap tables are important for many reasons. They provide an ownership breakdown, they help track the value of a startup over time, they’re critical for the fundraising process, and they can even be a godsend in the event of a financial audit.
Let’s break each one of those down and take a closer look.
They provide an ownership breakdown
Founders need to be aware at all times of what their cap table means for ownership of their company. Understanding who owns what is critical as the company grows and develops.
It also gives investors the ability to run forecasts on potential payouts and dilution based on their ownership split. The breakdown of ownership in a startup can affect the overall value of the company for future fundraising rounds as well as who needs to be at the table for certain company decisions.
They’re useful for value tracking
An up-to-date and detailed cap table is crucial for tracking the value of a startup over time. Value tracking allows an analyst to track the progression of overall company value as time goes on. The ability to track in real-time is an important component of the value of a cap table as well.
Beyond being a useful tool for current investors and founders, cap tables are important for employees as well if they have been issued stock options or equity stakes in the company. A cap table allows them to see if their company is genuinely making progress!
They’re critical for the fundraising process
Now that you know exactly what a cap table is and the purpose it serves, this one might be self-explanatory. But in addition to current investors using a cap table for forecasting and dilution predictions, future fundraising can also be affected by cap tables.
Using a cap table, potential investors can evaluate how much control and leverage could be maintained during term sheet negotiations. Historical insight provided in a cap table can affect negotiating current valuation for new funding raises. Additionally, an existing shareholder can easily determine what percentage of the company to give to the new investors in exchange for the capital contributed.
They can help with audit support
In the event of an audit, a well-managed cap can allow your legal team to present your company’s history and holdings with accurate and well-organized information via a cap table. In general, a well-organized and well-maintained cap table is critical for the health and growth of a company across all financial situations.
What a cap table looks like (with an example)
Now that we’ve covered what a cap table is, and why it’s important, it’s time to dive into what these things actually look like!
First, it’s important to note that the structure of a cap table may vary with company needs. In some instances, you might see the cap table go into significant detail on the stakeholders and in other cases they might be grouped quite simply.
There isn’t just one way to build a cap table. Based on the size of the company, stage of growth, and ownership structure, a founder will adopt the preferred approach best suited to their business. Typically however, cap tables are built out on two axis’. The basic requirement is to have the list of stakeholders on the Y-axis and details of all the securities on the X-axis.
There are of course some basic parameters that must be included. These are:
- Name of all shareholders
- Number of shares owned by each shareholder
- Percentage of ownership held in the company
- Total number of outstanding shares
- Total number of stock options available for new issuance
- Option pool
Most folks will follow a pattern while listing stakeholders in a cap table structure. First, the founders are listed, followed by the executives, then the employees holding stocks, and later the external stakeholders such as angels and venture capitalists.
Let’s take a look at a basic example.
In this example, you can see all the key elements of the table: post-money valuation, price-per-share, shareholders, how much shareholders paid for shares, and what percentage of ownership it gives them pre and post-money.
As you’ll also see in the example above, there are some startup-specific finance terms it’s helpful to understand in order to read it.
- Pre-money valuation — The value of the company before the most recent funding round.
- Post-money valuation — The value of the company after the most recent funding round.
- Common stocks (or common shares) — The standard stock that is created when your company forms (usually the type of stock founders and employees receive).
- Preferred stocks (or preferred shares) — The type of stock most investors buy in a company as it’s lower risk. If your company is liquidated or pays dividends, those who have preferred stocks will be paid out first. So investors with preferred stocks will receive their money before those with common stocks.
- Options — Stock options are the right to buy shares at a set share price. An employee can choose to exercise a stock option and buy shares, reducing the number of stock options left in the pool.
- Convertible notes — A type of debt that exchanges investment up front for the right to redeem shares when the company hits an agreed milestone. Convertible notes are a common way for early-stage startups to raise money.
- SAFE — This stands for Simple Agreement for Future Equity. A SAFE agreement exchanges investment up front for the promise of future equity ownership. However, unlike convertible notes, SAFE doesn’t have a maturity date or carry interest.
- Outstanding ownership (or outstanding shares) — The percentage of the company each investor or founder owns out of all the stocks that have been issued, including total common stocks and preferred stocks but not including stock options that haven’t been issued yet.
- Fully diluted ownership — The percentage of the company each investor or founder owns out of all the available security types, including common stocks, preferred stocks, available stock options, and any convertible notes or SAFE.
How to Maintain a Capitalization Table
It’s one thing to build your initial cap table at the start of your business, but maintaining it is essential, as things (like your equity structure) have likely changed. For example, more funding rounds and more employees can affect the numbers in your table. As such, keeping it up-to-date ensures you always have the correct information and can refer back to it when necessary.
Here are some of the most common items to keep track of and update when necessary on your cap table:
- Valuation - as in whenever your stock price changes, update it.
- Investors - as in whenever you take on new investors, add them to your table.
- Reserve/restricted Stock - as in if you offer stock options to employees, update the number of shares when you hire new folks
- Debt that has converted to equity
- Total outstanding shares
- Remaining authorized shares
It’s also important to ensure that there is at least one person dedicated to keeping the cap table up to date (usually this is the CEO or CFO’s job). If various groups have the ability to make updates, it can get confusing if people are on different pages.
There are some software products out there that help automate and simplify the process of building a maintaining a cap table. The most well-known most likely being Carta.
You can often get by in the early days — when you don’t have outside investors — using an Excel spreadsheet. Once you begin your first funding round, however, you should onboard your company onto a cap table management software platform.
Typically these softwares come with a much more flexible and user-friendly approach than doing things with a good ole’ fashioned excel sheet. These are designed by companies specializing in equity management and are a consolidation of best practices across all stages of business and diverse industries.
We’ve talked about how cap tables can provide a detailed ownership breakdown, how they help track the value of a startup over time, the important role they play for the fundraising process, and how they can be super helpful in the event of a financial audit.
When a company is just getting started, your cap table will likely only contain the founders’ ownership stakes, but as a company scales and matures, the cap table can become must more complicated. Especially if it’s not updated on a regular basis.
Founders already have so many things to do, so it’s easy for cap table management to fall through the cracks. Neglecting your cap table can have serious consequences so don’t be afraid to ask for help!
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