Introduction to Cap Table
The cap table is a simple yet detailed document that resembles a conventional spreadsheet, which displays all the shareholders in the business and how many shares each of them owns.
Are you starting your own business and a bit overwhelmed on how to manage all the administrative work, like organizing company documents and recording the company shareholders? Well you should consider creating a cap table to keep all your company shares and list of shareholders in place. A capitalization table, also called a cap table, is one of the most common and crucial lists that every entrepreneur needs to know to make smart decisions in their business life cycle. The cap table is a simple yet detailed document that resembles a conventional spreadsheet, which displays all the shareholders in the business and how many shares each of them owns. Nevertheless, the simplification of what the table holds is not the same as the efforts required for the management of the table. Investors want to clearly understand who you have mentioned on your cap table and why. Other than this, as your company grows, you would also want to know how your ownership would be affected if someone buys shares of your business.
This article explains all you need to know about the cap table so that you can fulfill the right needs of the business as an entrepreneur.
A lot of entrepreneurs out there know the basic idea of a cap table, but do they actually understand what the key essentials are? In case you are an entrepreneur, you know that a cap table is a spreadsheet that holds the details of all the shares of the company. Well, that is just the tip of the iceberg, and there is a lot about the cap table that is more than merely a representation of any transactions that have taken place in the business. The cap table has many more legal documents and transactions, which also includes:
- Exercises of options
- Conversions of debt to equity
- Stock issuances
So, let us understand what the cap table is and what items there are.
What is a cap table?
A capitalization table is a list of the company’s securities and who owns it, at the most basic level. The securities of the company mean the warrants, options, shares, etc. In short, the cap table tells you who owns what in your company’s structure. There are more complex cap tables which include the formulas that display the models of several hypothetical transactions. These transactions include public offerings, sales of the Company (M&A), or new financings. Cap tables can be detailed in nature, where you can provide the granular detail on each owner’s holdings and each type of security. On the other hand, cap tables can also be summary, where you can group all the holders into simplified buckets like the “investors” and “founders” and/or group the various series of preferred shares into one preferred share bucket.
Why is a cap table important?
When a business grows and develops, the cap table would show all the investments that were made over time, along with the principal shareholders of the company. These points are essential for making any hiring and financing decisions for the company, keeping in mind how it would affect the equity and shares of the business in the future. For instance, let’s say your CEO provides a proposal to the investors, demanding for equity compensation comprising a specific percentage of the corporation. With the help of a detailed and well-organized cap table, you would be able to figure out the degree of the equity dilution that you, as well as the other shareholders, would suffer from this. Along with this, you would be able to see the specific number of shares that the percentage would represent and make a quick decision if you accept the demand or not. All in all, the cap table would be able to provide you with a clear visualization that would include all the details needed to make a decision, right at your fingertips. Your decision making would become faster and smarter, and you can get back with an answer regarding their demands.
Different Features of a Cap Table
Now that you know what makes the cap table something important for every entrepreneur, let us see what makes up the cap table as a whole. Many of the businesses just use a spreadsheet to make their cap table as soon as the company has been incorporated. The cap table needs to be designed in an organized and simple layout that clearly displays every detail for anyone to understand. One of the most common ways is to list the names of the security owners and investors on the Y-axis of the table and the type of securities on the X-axis of the cap table. The best way to avoid any confusion is to use an app or a template that would save you time in creating the cap table. All you would need to do is add the values in the spaces. The first would have the total number of shares that the company has, while the next rows would hold the following details:
- Authorized shares: The total number of shares that the corporation can issue.
- Outstanding shares: The total number of shares that are held by the company’s shareholders.
- Unissued Shares: The total number of shares that are left to be issued.
- Shares kept for stock option scheme: These are the shares that have not been issued and are reserved for future hires.
That is not all. There has to be another table in the cap table which should hold the following things:
- Names of shareholders: Those shareholders who have bought shares of the company.
- Shares owned by each shareholder: The total number of shares that each of the shareholders holds of the company.
- Stock options: The stock options that each shareholder owns.
- Fully diluted shares: The total number of outstanding shares, which assist the shareholders in figuring out the value of the shares they hold.
- Stock Options remaining: The total number of stock options available for any new shareholders who might join in the future.
In the cap table, first the founders of the company are listed, then the executives and then the other employees who hold equity of the company. After these, the investors are listed which includes any venture capitalists, or angel investors who own shares of the company. With the format of the cap table and what it holds, how do you use it for making the right decision in issuing another stock option or shares to new staff? Well, here are the four questions that would help you as you are hiring new staff or selling a share of the company, as you keep tabs on the cap table for your company:
How many outstanding shares are there?
When looking at the equity of the company, this has to be the very first question. For example, if a person has just four hundred shares out of 1 million shares of the company, they have a little of the company. On the other hand, if the person has four out of twenty shares of the company, then they hold a huge part of the business. Issuing another share means diluting the shares of the existing shareholders as well as your profits.
Which type of investors are purchasing the shares?
The company’s longevity and main decision making depends entirely on the types of shareholders the company has. Learn all about the investors and then agree on issuing shares to them, as they would be a big part of the company later on, and you do not want to lose the company or make wrong decisions.
What is the exercise price of your company’s share option at the current period?
The price at which you would sell the options of your company is the exercise price. The prices would change when the value of the company changes, as they are based entirely on the fair market price and are non-negotiable.
What is the vesting schedule you offer?
The vesting schedule of the company is when the shareholders get an incentive to stick around with the company and not sell off their shares right away. Hence, you need to have open options for the investors and staff to have the encouragement of sticking with your company for a long time.
Way to Keep Track of your Cap Table
The cap table that you have created for your company has to be up to date at all times. You should have a well-organized cap table to make immediate and smart decisions about the shares of the company. Moreover, there isn’t any right or wrong format for the cap table, and it depends on the reasons why you are looking at the cap table. As a matter of fact, the form of the cap table would change along with the company, but the main data would always remain the same. With the following tips, you would be able to gather, organize and maintain the cap table and the data in such a way that it stays useful:
Keep it Simple and Organized
This would help you find the details easily and make decisions faster. In short, the cap table should be a collection of ledgers that hold the following details:
- Stockholder name
- Date of issuance
- Number of shares issued
- Date of disposition, if the share is no longer outstanding
- Concise and consistently-worded commentary
Design Your Cap Table to Your Corporate Documents
In case your company is supported by VCs, you are directed by “protective provisions” and need you to get the approval before taking some decisions. For instance, for having a new funding approved, your code needs you to get the approval from:
- A majority of the Series A shares; and
- A majority of Series B and C together.
You would be able to make decisions easily and faster if your cap table has the columns that display the percentage of Series B and C shares held by each holder together, and the percentage of Series A held by each holder. With this, you would be able to determine who to collect the approvals from, for the new financing. In short, you shouldn’t have to do the calculations from the beginning each time you open the cap table.
Use Microsoft Excel
During your business life cycle, there would be many times where you would need to share your cap table with many people. Hence, it should be in the format where it is easily manipulated and accessed by anyone. Moreover, Excel has many range in formulas and everyone uses Microsoft Excel. After your company gets bigger, think about migrating your cap table from excel to software that manages cap tables online, and all in real time.
Use Consistent Names
Keep the same names that you use and be consistent with it in the complete cap table. This means that do not use the complete name in one place, and then use the nickname in some other place. It would confuse both you and anyone you share it with.
Keep Stockholder and Optionee Data
Even though most of the information in the cap table is from the particular parts of an option grant agreement or a stock certificate, some things are stockholder-specific. This means, adding the email addresses and the physical address of the shareholder can come in handy. Moreover, ensure that you get their home address since a person can leave the company and you would need a way to contact them after it.
Avoid Aggregating Stock Certificates
In case there is a shareholder who is being issued shares from many sources, avoid aggregating the shares into a single certificate. This is because not all the shares are the same and with noting the details down now, you can save time and money later on. The same logic applies to every other detail on the cap table.
Example of a Company’s Cap Table
To understand the concept of the cap table, let us talk about a case study where there are two founders named Joe and Jack, who have an idea of a restaurant that delivers groceries via drones to everyone in Silicon Valley and beyond. After they have set up their company, they decide to split their stakes at a ratio of 60:40, where Joe gets the most since he was going to be the CEO of the company and has a great technical background. Other than that, they decide to keep 20% shares in the pool of equity for future employees. And with this, here is how the stakes of the ownership break at the beginning:
- 48% to Joe
- 32% to Jack
- 20% for an employee pool
They kept the name of the company as The Tech-Savvy World, and it was incorporated as a C-corporation in Delaware. This means that it had 10,000,000 shares of Common Stock outstanding, that would be issued at a par value of $0.001 per share. And at the current point, the company has the value of $10,000. Jack works on the food and Joe works on the drones. After working for months on this, they successfully begin their business with their first flight. The idea was great and the demand was high, but the cash to run the business wasn’t there. That is when Joe feels that outside funding is needed for the seed capital.
The Seed Deal
There are two types of seed rounds: unpriced and priced. They choose the unpriced seed round where the company is not given a valuation, and the investor is not buying an equity while investing in the company. Instead, the investor has an agreement for having shares issued for him later in the future, which is priced round in exchange for the investment made at the time the unpriced Seed deal is struck. Joe and Jack decide to raise the capital in the unpriced seed round where they needed about $6 million to get their company off the ground. Two investors are found who are ready to invest in the company:
- BlackBox Funding would invest $3 million which has a $10 million valuation cap on the pre-money valuation of the company; and
- Transparent CVentures agrees to a $3 million with a 20% discount provision.
The agreements are signed and money is provided. Keep in mind that no share has been issued as of yet, so the cap table remains the same.
Series A dynamics & Deal
Fast-forward 24 months. All is going great and there is a need for another investment since the company is not profitable as of yet. The next round is Series A after the seed funding (read types of funding to know more). Joe and Jack determine that they need $8 million and find two investors to help out in this. ABC Ventures would lend about $4 million by leading the round. And BCD ventures are participating with an investment of approximately $3 million and CDF Funding decides to join in and invest about $1 million.
Investor shareholding breakdown
Before any of these investments, the company’s value is put at $15 million, by outside analysts. As per the Series A, the price per share is $1.50. We get this value from dividing the $15 million pre-money valuation by 10 million shares.You may think that the total sum of the post-money valuation would be this plus the amount being raised, but that is not the case here. With this step now, both Jack and Joe update their cap tables to keep a track of what just happened. Let us now understand how the investments convert into equity here. Transparent CVentures invested $3 million with the capability to buy the shares at 20% discount to the pre-money valuation at Series A. With a 20% discount, the value is $1.20 per share. Now, Transparent CVentures invested $3 million, and for that, they get about 2,500,000 shares ($3 million divided by $1.20 per share) which has a value of now $3.750 million, which is 1.25 into the invested capital. In the first seed round, BlackBox Funding invested $3 million with the cap valuation of $10 million. And due to this, they can buy the shares at $1.00 per share ($10 million cap/10 million shares outstanding). In short, they buy 3 million shares from the seed investment. With the new share price of $1.50 per share, their investment is now valued at $4.5 million, 1.5 times the invested capital. Now moving ahead where ABC Ventures, at a share price of $1.50, they can receive 2,666,666 shares with the investment of $4 million. BD Ventures purchased 2,000,000 shares with the $3 million investment. In this round, with a $1 million funding, CDF Funding buys 666,666 more shares out of the Series A stock.
Now, after the Series A round, the ownership of the company has broken down. The valuation of the company after raising the Series A round is about $30 million. And if you remember, we had hoped that the valuation would be 22 million, after adding the total amount funded again along with the previous valuation of the company, which didn’t work that way. Moreover, any clause for discounts or valuation caps allows the investors to buy the shares are a lower rate, which means that they can buy many shares in the end. Other than this, it is vital to note that the share percentage of Joe, Jack, and the employee equity pool has reduced. This is called dilution. And if we look at the dilution financially, it not the end of the world, as a shrinking slice of the current pie is still valuable if the company’s size continues to grow. However, dilution matters a lot in cases that the company doesn’t grow fast or doesn’t grow at all. In short, before the Joe and Jack can move to another round to raise funding by exchanging the equity, they need to see if their decision would not affect the ownership.
In short, being an entrepreneur means that you need to create a proper cap table and keep it with you. This cap table has to be well-detailed and organized for you to make decisions when needed. From our example, you can see that the shareholding can become quickly complicated with various investors and Series fundings. To learn more about the cap table in details and the mistakes to avoid in a cap table, check out the next articles.