If you have recently launched a new startup, your mind might be a battlefield by now. You must be struggling with the harsh facts that only the best startups can survive in the competitive business world. In essence, you are bound to pay close attention to each & every aspect related to the growth of your business.
Therefore in this post, we have tried to cover the basics of one of the most potent tools for any company, the cap table. It not only helps to grow your startup, but also in managing the administrative tasks of your business. From organizing the documents of the company to recording the shareholders, a cap table can record all such critical tasks effectively.
In short, a cap table for startups helps in doing the groundwork of the analysis of a company’s percentages of ownership, investor’s details, equity dilution, and equity value at each round of investment.
Let us gather some info about the cap table to understand its importance for the growth of a startup along with an easy step-by-step guide to create it.
What is a Cap Table?
By definition, a capitalization table or cap table for short, is a spreadsheet used by startups to show the overall capital structure of a company and the ownership stakes that includes founders, investors, and employees.
“Ownership stake represents the percentage of ownership of each shareholder in the company. Simply, it tells who owns what amount of the business.”
It also lists the securities of the company like the shares, stock options, warrants, share classes, convertible notes, and the invested amount. These company transactions affect not only the founders, but also the investors, employees, and other involved third parties.
Ultimately, a cap table allows gathering the facts about the ownership of the company shares, the shares held by each shareholder, and dilution of the share price over time.
What Is The Importance Of Cap Table for Startups?
At each stage of your startup, it is very critical to understand who owns what, and a cap table makes it more accessible. There are multiple variables involved in this process. It is the primary reason a cap table for startups was created to track all of this data.
“A well-managed cap table for startups helps to attract investment and prevent diluting your stake”.
There are various reasons why a startup has to maintain a cap table religiously. Have a look at a quick summary explaining these significant ideas.
- The primary reason to maintain the cap table for startups is for investors. They usually forecast the dilution under particular scenarios along with potential payouts. It also tells the percentage of control over the company.
- To grow a company, every startup requires investors. And the cap table for startups helps potential investors decide on the leverage & control they can maintain during the negotiations.
- Another reason to maintain a cap table is that it aids to build a trust-worthy relationship between the employees and the owner. The transparency a cap table provides to the employees allows them to see their real-time value of their stock options or equity stakes.
- A cap table structure provides a historical insight into the aspects required for negotiating current business valuation. It is also essential for raising funds and attracting new potential investors.
- A well-managed cap table allows the legal team to present the holdings of your startup along with well-organized and accurate information. It even represents your company’s history to the audit team, that increases the credibility of your business.
Before we move forward towards the process of creating a Cap Table, let us delve into some of the critical factors that may affect its creation. The transactions & factors mentioned below have an impact on the number of shareholders and the overall share distribution.
1) Stock Options
It is a type of compensation contract between a receiver and the company that allows them with an option to buy or sell a stock at a fixed price before or on a specific date.
The stocks are issued to founders, investors, or employees (employee stock option (ESO)) or as compensation for their services. It includes the grant date, number of shares, the strike price(which is also called a fixed price), cost, receiver, exercise date (if any), and the vesting start date.
“When the options contracts are exercised, it affects the overall cap table of the company.”
The effect of stock warrants on the cap table structure is similar to options. It is a derivative that gives the right to buy or sell equity (or security) at a fixed price before it expires.
The major difference between warrants & options are that options can be issued by a separate investor(who holds the company shares), but a warrant is always directly issued by a company.
A stock warrant also includes a receiver, the strike price (fixed price), grant date, cost, number of shares, exercise date (if any) and the vesting start date.
“When a warrant is exercised, a warrant certificate is issued to the investors. Like stock options at this time, it affects the cap table”.
It is a type of investment that can be converted into another form, like debt are converted into equities. It usually has a lower payout that could be accepted by investors due to the potential profit through the conversion feature.
The most common type of convertible securities is convertible preferred stock or convertible bonds that can be changed into equity.
“Equity derivatives affect the cap table concerning the mechanics of conversion.”
4) Restricted Stock
In general, employees can benefit more from restricted stock when compared to stock options. These are the company’s unregistered shares that are usually issued to the people inside the company, like the directors, executives, etc.
These type of shares, when traded, must adhere to special SEC (Securities Exchange Commission) regulations as they are non-transferable. They are usually fully vested after meeting specific criteria or conditions like continued employment.
“Note that if you are pre-equity and are still granting restricted stock, you should note in your cap table about the employees that have filed an 83b election”.
5) Restricted stock units (RSU)
Similar to restricted stock, restricted stock units (RSU) are also a form of employee compensation. Once specific performance goals are achieved, this type of compensation is allocated. However, these RSUs are not issued until the vesting is complete (similar to options).
This means that the share number is not diluted immediately and plays an important role in simplifying the bookkeeping & taxation. Especially, it remains easy until the stock units are converted to shares.
To stay on top of everything, you should avoid costly mistakes and learn to create & manage cap table, especially at the seed stage/pre-equity stage.
By now, you might have a better idea about the significant factors that affect the creation of a cap table. Let us now move on and discuss the general steps that help to create an efficient cap table for startups.
How to Create A Capitalization Table?
Most entrepreneurs make use of spreadsheets for creating their cap table. It’s a relatively simple process at the beginning of any business. However, over time, managing a cap table becomes a tedious task as more and more variables are added to the company.
Therefore, most companies prefer to consult a business attorney to make sure about the effectiveness and the accuracy of their cap table structure. If you are about to create your first cap table, you can follow the points below.
We would first begin with the most common cap table structure – using a sample spreadsheet. It should be precise & straightforward in design and must hold the required information about the ownership of shares as well as the outstanding shares.
As per the standard cap table structure, you need to mention the investors/security owners name and the securities of the company. The best part about creating a cap table is that you even have the option to use a spreadsheet template that allows for critical input of figures & other business-related information.
Note: The total number of the company’s shares are indicated in the first row.
The succeeding rows should include the following features:
The total number of shares that a corporation is allowed to issue legally, as specified in its articles of incorporation. It is also called authorized stock or authorized capital stock.
For many public companies, the shares issued to the public on the open markets incorporates a considerable portion or all of a company’s authorized stock.
It is also customarily listed in the “Capital Accounts” section of the balance sheet
The total number of shares of a financial asset or corporation that have been issued, authorized and purchased by investors.
The shares outstanding can help in calculating the key metrics such as Earnings Per Share, Cash Flow Per Share, as well as the company’s market capitalization.
It is that part of the company’s shares that has not been issued yet. A larger number of unissued shares means a higher chance the board of directors could potentially sell, or issue without prior investor approval. It can reduce the total earnings per share.
On the other hand, a small number of unissued shares restricts the capability of the board of directors for issuing more shares. Also this restricts the company from declaring a stock split or stock dividend.
Shares reserved for stock option plan
It means the authorized shares or unissued shares that are set aside in the option pool for future hires. This is typically when the organization raises funds by issuing preferred stock. At this time, a particular number of authorized shares are reserved for the conversion of the preferred stock into common stock.
Apart from the information mentioned above, a cap table carries a lot more information regarding your business. You may require access to this information anytime in the business growth plan execution.
Here is the list of other critical business parameters for which a separate table in the capitalization table is made:
- Names of shareholders: The names each individual shareholder who bought shares in the company.
- Shares owned by each shareholder: The number of shares of common stock held by each shareholder.
- Stock options: List the total number of stock options owned by an individual shareholder.
- Fully diluted shares: The total number of common shares of a company including the outstanding issued shares along with the ones claimed through the conversion of convertible preferred stock.
- Options remaining pool: It represents the total number of remaining shares available for an option pool.
By now, it is clear that with the addition of more transactions, the cap table becomes increasingly more complicated. Therefore, you might also need to create additional pages that are linked to the main table.
Usually, the subjects for these separate pages may include:
- lists of shareholders for each type of stock
- a vesting schedule
- table of investors
- table of shareholders
“Every company has a unique structure and requirements, and the addition of separate pages mostly depends upon this fact”.
How easily you can create your startup cap table with Eqvista?
Once your company profile has been created, you can start creating share classes, options, warrants, and convertible notes accordingly to your company’s structure.
Creating these can be done from the main dashboard on the right hand side, or on sidebar directly for each equity class on the left.
If you choose to create these directly for each security, you will need to enter the details for each security from this screen.
For creating a new equity class (in this case an option class), you will need to fill in the key details of this class. For a new option class, it would be the underlying security (share class), the option class name, the amount of shares reserved for these options, and the board of approval date.
Once you have created all the equity classes of your company, you can then begin to issue these to your shareholders. If you haven’t added your shareholders yet, you can simply add them at the time when you issue these shares.
On the share issuance screen, you would again need to add the key information as according to your company details, for the underlying security (equity name), shareholder name, date of issuance, number of share issued, price per share, share name, and vesting schedule (if any).
You may find going through each page for creating and issuing share for your company profile, that the Eqvista app was made to be user friendly and efficient in creating new cap table for startups.
After you have entered in all the details and issued equity to all your shareholders, your cap table should now be complete. You can view a summary or detailed overview of the cap table, as below:
The information mentioned above is self-evident of how simple & straightforward it is to use the “Eqvista App” to create a cap table. You may also visit the Eqvista website to learn more about the details of the cap table and common mistakes to avoid for keeping a correct & updated cap table.
In this post, we have outlined the importance of creating a cap table for startups and its role in taking the critical decisions concerning your business transactions, percentages of ownership, value of equity and much more. It is clear that recording improper transactions, or having an outdated cap table may lead to monetary and credibility loses of your business in the eyes of potential investors.
Therefore, to overcome such issues, you can try the Eqvista platform. It utilizes the latest technologies to issue stock and stay connected with your shareholders. It has been accepted by various companies as the best tool to create cap table for startups on the market today.