Stock options: How to include them in the cap table?
This article will cover an in-depth idea about stock options, cap table for employees, stock options cap table and employee stock options.
A cap table, also known as a capitalization table, provides a detailed breakdown of a startup’s ownership & the ownership structure of a startup. Cap tables are important documents that help founders and investors make more informed decisions about the company. It is a spreadsheet that shows who owns what in a startup.
The cap table is an important due diligence item because it shows how a fundraiser affects each stakeholder. As a result, understanding how to interpret them as an investor is critical. It’s also critical for any entrepreneur to understand who owns what at each stage of the business, whether you conduct due diligence to raise funds or simply incorporate a new business. A startup’s cap table will likely become increasingly complex as it grows. This article will cover an in-depth idea about stock options, cap table for employees, stock options cap table, employee stock options, and cap table example.
Stock options and cap table
A Cap table is a startup /early-stage venture spreadsheet that lists the company’s securities, including common shares, preferred shares, warrants, who owns them, and the prices investors pay for them. It shows each investor’s percentage of company ownership, the value of their securities, & dilution over time. In the early stages of a startup/venture, cap tables are created first before any other company documents. After a few rounds of financing functions, the cap tables become more complex, listing potential funding sources, initial public offerings, mergers and acquisitions, and other transactions.
Understand a cap table
A capitalization table lists a company’s securities, including common and preferred stock, options, SAFEs, convertible notes, and warrants. It also shows how much each investor owns of each security type, the value of their stakes, and their current ownership percentage.
A cap table, in other words, is a comprehensive listing of everything an investor would want to know about a company’s ownership. A cap table includes many legal documents, in addition to transactions, such as stock issuances, transfers, cancellations, debt conversion to equity, and other documents. The executives must accurately manage all of these transactions and documents to demonstrate the events since the company’s inception.
The simplest form of cap tables begins by listing the shareholders and their respective share ownership. Venture capitalists, entrepreneurs, and investment analysts use cab tables to analyze important events such as ownership dilution, employee stock options, and the issuance of new securities.
Benefits of a cap table
Cap tables are the standard reference document for any equity-related decision. The following are the most important reasons why a startup should have a cap table:
- Cap tables aid in the computation of market value. The cap table is used for all shareholder reporting and new capital issuance.
- Existing shareholders understand how much dilution can be tolerated by new investors.
- Potential investors can estimate their current shareholdings and the leverage they may have if they decide to join in.
- Employee equity management is transformed into a transparent process. Employees who own shares can see their worth in real-time.
- A historical look at cap tables can provide a sense of the business’s health and a much-needed competitive advantage when attracting investors.
- A well-organized cap table enables the startup’s audit and legal teams to establish the value of the business by considering best practices.
What does a cap table include?
While there is no standard form or format for a cap table, it should include the following information:
- Shares with authority
- Shares in circulation
- Unissued stock
- Shares set aside for stock options
- The last priced round’s valuation details (including pre-money valuation, amount of new equity raised, per-share price, and number of shares)
- Complete shareholder list (including the type of shares they own, the total number of shares, and percentage ownership stake)
What are stock options?
Employees are frequently granted equity. An employee is granted the option to get a certain percentage of company stock for a predetermined price known as the exercise price/strike price at the time of grant. The idea is that the company’s share value will rise over time, and when the employee decides to practice their options, they will profit from the price differential generated by the actual share value. Thus, stock options grant employees the right to purchase stocks at a discounted price rather than the stock itself. Vesting schedules and cliff periods apply to stock options.
An employee stock option plan (ESOP) is a legal document that allows a company to grant stock options to certain employees, directors, advisors, & consultants. ESOP is used as an ownership incentive for the team to increase the value of the business for both shareholders and themselves. It is a critical compensation tool in technology companies for attracting, motivating, and retaining a great team.
How do stock options work for employees?
Employee stock options are equity compensation plans provided by companies to their employees. These grants take the form of regular call options & give an employee the right to get the company’s stock at a predetermined price for a limited time.
Vesting schedules in Employee Stock Options (ESOs) can limit the ability to exercise. ESOs are considered vested when the employee is permitted to exercise the options and purchase stock in the company. In some cases, despite exercising the stock options, the stock may not be considered to be fully vested when purchased with an option, as the company may not want to risk employees making a quick profit (by exercising their options & immediately selling their shares) & then leaving the company.
ESOs are taxed when exercised, and stockholders are taxed when they sell their shares on the open market. Even if they have no or little intrinsic value, they can have significant time value. An option’s value includes intrinsic & time value (extrinsic value). The amount of time until their expiration & several other variables determine the time value. Most ESOs have a stated expiration date of up to 10 years from the date of the option grant, its time value can be substantial. The time value for exchange-traded options can be easily calculated, it is more difficult to calculate the time value for non-traded options such as ESOs because no market price is available.
Benefits of employee stock options
The following are the primary advantages of any type of equity compensation plan for employees:
- An opportunity to directly participate in the company’s success through stock ownership
- Employees may be motivated to be more productive as they own a stake in the company.
- Provides a tangible representation of the value of their contribution to the employer.
- Depending on the plan, it may provide the opportunity for tax savings upon the sale or disposition of the shares.
Cap table for employees
Employee equity management is also an important component of business strategy. Here are some ideas for you to start with:
Employee Equity is considered a part of the Employee salary. Even though it is not paid in cash, it’s still part of the salary structure in the form of startup equity compensation. Thus, revealing this information is equivalent to publishing salary information for all employees, which makes no sense.
Employees must understand how much equity they own, its current value, and the preference level that precedes them. It is unnecessary to share such information as long as it is provided. Using excel sheets to provide customized access is difficult. However, cap table software offers this personalized feature to each employee.
Types of employee equity or stock options included in a cap table
Employers can offer two types of stock options:
- Non-qualified stock options (NSO) – Employees at all company levels, even the board members & consultants, can be granted non-qualified stock options (NSOs). Profits from non-statutory stock options are treated as ordinary income and taxed accordingly.
- Incentive stock options (ISO) – ISOs, also known as statutory or qualified options, are typically only granted to key employees and top management. In many cases, they receive preferential tax treatment because the IRS (Internal Revenue Service) treats gains on such options as long-term capital gains.
Benefits of granting stock options to employees
Employers can benefit from an equity compensation plan in the following ways:
- It is a critical tool for attracting the best and brightest in an increasingly integrated global economy with competition for top talent.
- Increases employee job satisfaction and financial well-being by offering generous financial incentives.
- Employees are encouraged to contribute to the company’s growth and success because they will benefit from it.
- In some cases, owners may use it as a potential exit strategy.
How to allocate stock options to employees and team members
With 1,176,471 shares outstanding, a 15% stock option pool would have an average of 176,471 stock options available. For venture capital, a “rule of thumb” allocation would look like this:
58,824 options, or 5%, for a CEO who took over from the company’s founder. If the founder stays on as CEO, this percentage would be split among other categories. A Chief Executive Officer or other high-level board members could fill this role.
A total of 58,824 options (or 5%) were granted to the executive team, with each executive receiving a 1% grant on average (sales executives with a variable potential financial benefit generally hold lower amounts of options while C-level executives like COO, CTO, and CFO would hold a higher amount)
An additional 58,823 options, or 5%, will be distributed to all other staff members. This includes external directors and advisers.
How to include stock options in a cap table?
At the start of a business, most companies use spreadsheets to make a cap table. The capitalization table should be in a simple & organized format that showcases who owns what shares & how many are outstanding. The most common structure involves listing the names of investors/security owners on the Y-axis and the type of securities on the X-axis.
Alternatively, a company can use a spreadsheet template to add business-related information and figures. The first row should show the total number of shares issued by the company. The following rows should be included:
- Authorized shares – The number of shares that the company is permitted to issue.
- Outstanding shares – Total number of shares held by the company’s shareholders.
- Unissued Shares – Total number of shares that have yet to be issued.
- Unissued shares set aside for stock option plan – Unissued shares set aside for future hires.
The following should be included in a separate table in the capitalization table:
- Shareholders’ names – The names of shareholders who have purchased shares in the company.
- Shares held by Shareholders – The number of shares each owns.
- Options on stock – Each shareholder has stock options.
- Shares fully diluted – Total number of shares in circulation (helps shareholders determine the value of their shares).
- Options remaining – The number of shares that can still be optioned.
Do employees have access to the company cap table?
As mentioned earlier, Employee equity is a part of the salary; even though it is not monetary, it is a form of equity compensation in startups. Thus, disclosing this information is equivalent to publishing salary information for all employees, which makes no sense.
Employees must understand how much equity they own, its current value, and the extent of preference preceding them. There isn’t much that needs to be shared as long as this information is provided. It is difficult to provide customized access using excel sheets. However, cap table software provides this personalized feature to each employee.
Board members, CFOs, key finance team members, legal team, and investors with significant information rights may be granted access to startup cap tables. These individuals are critical to driving business and must be aware of cap table status to plan a secure financial future for the startup.
How to manage your employee cap table (ESOP) on Eqvista?
Eqvista offers cap table software to assist with share control. Our technology facilitates the cap table management process by allowing you to create several asset classes, including options, warrants, and convertible notes, all in one spot. To get started, just establish an account on Eqvista and register your business profile. Handling a cap table can be strenuous and intricate, but Eqvista simplifies the process by:
- Maintaining compliance with laws.
- Keeping the most recent records of the stock in your firm.
- An easy update for everybody on cap table modifications, particularly founders and shareholders.
- Recording information on shareholders and the company’s stock.
- Centralizing data to make it simple for others to share it.
Manage your company ESOP with Eqvista!
If you want accuracy, convenience, and simplicity throughout the ESOP distribution and valuation process, go with Eqvista. The cloud-based equities management solution from Eqvista allows investors and shareholders to manage cap tables, valuations, equity shares, and much more. Users may electronically issue and transfer common shares to investors, founders, and employees using a centralized share management platform.