A capitalization table, or cap table as it is more frequently called, is necessary for any startup. But for many startup owners, setting up and maintaining a cap table can be intimidating as they might not fully understand how your startup capitalization table functions or its role in their company’s finances.
The capitalization table, also known as the cap table, gives the information you need to comprehend your company’s ownership. It entails the details of company shares and shareholders. Any aspiring entrepreneur needs to understand the cap table to comprehend the firm’s equity ownership.
Let us dive further into the world of startup financials. In this blog, we will understand the cap table meaning and how startups should maintain their company’s cap table.
What Is A Cap Table?
A capitalization table, also known as a “cap table,” is a table that shows the capitalization of a company. A cap table enlists all the shareholders and the stocks that are allocated to each shareholder. A business uses the cap table to keep track of the overall number of shares, their market value, and the equity stakes held by each startup shareholder.
A startup’s cap table lists all the shareholders, including the founders, angel investors, venture capitalists, and any workers or advisors who own the company’s stock. The firm’s ownership structure is displayed in the cap table, which also assesses the proportion of ownership, equity depreciation, and cost of ownership at each round of funding.
Basics Of A Cap Table
Typically, a company’s cap table is maintained in the form of a ledger or a spreadsheet. A cap table is, thus, in its most basic form, just a column of names (the stockholders) with a field of values (the shares) next to it. However, for some startups, the cap tables may be highly complicated. The complexity of the cap table will depend on how you choose to structure your company’s stocks.
A simple cap table lists the number of shares owned by each stakeholder in a company. Once the business starts operating, most capitalization tables are maintained as spreadsheets. A few essential components should be the focus of a carefully planned structure.
A simple cap table has the following elements:
An individual or an entity holding the company shares is a shareholder. Owners of a company’s stocks are referred to as shareholders. As mentioned, the shareholders who have purchased firm shares are listed on the cap table.
The total amount of shares the startup owners have set aside for distribution is known as the sanctioned securities. These are the maximum number of shares a startup can legally issue to its investors.
Common shares are a part of the equity ownership of a company. These shares are usually given to business owners and investors, as these shareholders have a voting right in the company.
Preference shares are a component of the share capital of a company that has the features of both common stocks and debt. This is a hybrid instrument with unique rights, as predetermined by the company. There are various kinds of preferred stock, each with a unique set of benefits.
A convertible note functions similarly to a short-term debt instrument. Investors buy convertible notes to loan money to a startup, and convertible notes are an alternative to principal plus interest lending. They generally convert into a company’s equity in conjunction with the subsequent financing round.
Among other characteristics, a corporation’s shares may be participating or non-participating. Shareholders holding participating shares are entitled to “participate” in the company’s equity growth and also have the right to receive dividends.
Non-participating shareholders do not benefit from the company’s equity increase.
Why Is A Cap Table Important?
Some entrepreneurs believe they don’t need a cap table because their company is just beginning to take off. Having a fully diluted cap table for your startup is vital to show how much ownership each founder has. Even if you don’t yet have any investors, the founding team holds 100% of the equity, which forms the foundation of an equity cap table. At a later point in time, when you’re speaking to new investors, you need to have a detailed description of an equity cap table.
Every time a firm issues new shares, it dilutes the venture capitalists’ equity. By releasing new shares, the equity stakes of existing shareholders are decreased. Bondholders are typically penalized when a firm raises extra equity capital, but dissolution can occur at any time. It is important to keep your cap table up to date for investors because they keep tracking the cap table to understand the ownership structure of the startup in which they invest. Your startup’s cap table must provide information about the potential dilution consequences of introducing new investors.
The term “ownership stake” describes who owns what percentage of a startup—its founders, investors, or employees—or who exercises control over it. A common practice is to list the shareholders’ names and the number of shares they possess in the ownership stakes section. This approach identifies who will approve the significant corporate actions.
Given below is an easy cap table example to help you better understand a cap table:
IMAGE REFERENCE: https://blog.hubspot.com/sales/cap-table
The cap table‘s depiction of money, possibly large amounts, is another critical characteristic. The stocks in the cap table keep increasing in value by two or three times higher as the firm develops and turns a profit. On a cap table, even a minor inaccuracy might result in a difference of hundreds of thousands, if not millions, of dollars.
It can be helpful if you hire a COO for the business and the applicant requests a share of the company. If this option is not accessible, you can quickly determine an estimated amount and the percentage you are willing to offer. In essence, it shows who is the company’s owner.
Factors That Affect The Cap Table
Listed below are a few pointers that highlight why a cap table is particularly required for a startup/small business:
- By using cap table software to gather important information, venture capitalists can determine the degree of ownership and influence they will receive at the time of startup funding.
- With a Cap table, current investors can discover who is in charge of the company and use the data to evaluate their position and anticipated profit.
- The cap table lets shareholders view their shares’ value in real-time.
- When it comes time for a fresh round of fundraising, the cap table data help investors understand the equity financing of the company and can in turn impact the valuation of your firm.
- In the event of an audit, it enables you to see the history of your business and possessions.
- Founders can use the information to create a new term sheet and determine what share of the startup they have to offer to new investors.
How Cap Tables Are Built?
Some companies begin by creating their cap tables using spreadsheet software or a template as a startup cap table model, such as the Y Combinator cap table software template. Most businesses quickly learn that using cap table management tools like Captable.io makes the task faster and more precise.
The cap table should have a clean, straightforward layout that shows who owns what shares and how many shares are outstanding. Look for some cap tables online to better understand how cap tables are built.
A vc cap table can be created in one of two ways:
By Way Of Spreadsheets:
Enterprises almost universally use cap table spreadsheets at the beginning of their operations. The most well-known format for creating a cap table is to list investors and owners of securities on the Y-axis and the type of securities on the X-axis.
A company may utilize a spreadsheet or a capitalization table template to add data and figures pertinent to their industry. The total number of shares of the corporation are highlighted in the first row of this spreadsheet. The shares approved, ongoing, uncirculated, and held for the stock option scheme and investors should all be listed in the following rows. Here is a sample cap table to improve your understanding of cap tables, made using spreadsheets.
IMAGE REFERENCE: https://articles.bplans.com/cap-table-explained/
By Way Of Using A Cap Table Software:
The number of investors and share classes grows with corporate expansion. Maintaining an excel cap table with several stockholders as the business expands can be a considerable burden. The inconvenience of continually adding more sheets is avoided by using cap table software, which can handle everything for you regardless of the size of your business.
How To Maintain Your Cap Table
Due to the likelihood that things have changed since you first launched your business, maintaining a capitalization table is crucial. For instance, higher investments, further funding rounds, and the addition of personnel can affect the statistics in the cap table. Keep your cap table updated so you always have the most recent data. On your cap table, remember to keep track of the following components and change them as needed:
Make a record of each transaction you create:
Make sure the cap table is always accurate. Maintaining minimalism and clarity can help you get the most out of a cap table. It entails updating any alterations caused by events like adding new shareholders, transferring shares between shareholders, exercising stock options, repurchasing shares back from the shareholders, and other transactions. Any of these may impact each shareholder’s total ownership of a firm.
Try to include information about Convertible Note.
Convertible notes are becoming more and more common among startups, particularly those in the seed stage. Most startups make a glaring mistake of not mentioning convertible notes in cap table. New investors may frequently be surprised by undetected convertible notes since they base their decisions on the potential dilution of their ownership stakes based on the figures mentioned in the cap table. What would happen if a new investment of $1 million with a $5 million pre-money appraisal contained $2 million in undiscovered notes? Rather than realising that they may control less than 20% of the company, the new investor would enter the market with this presumption.
Always plan ahead for providing ESOPs:
Using employee stock options in startups serves two purposes. They’re initially employed as an incentive for the top management in a startup. The ability to purchase a set quantity of company shares at a predetermined strike price is granted to employees who exercise their stock options, assuming they are already acquired.
Secondly, stock options enable firms to reward people without raising their cash flow rate. While limiting their cash expenditures, stock options help firms expand and recruit top employees. From an equity point of view, employees should be given stock options as they may be expensive, but the firm won’t have to make any more payments.
Employee option funds are increasingly a common feature of startups, but the size off ESOPs is commonly mentioned during fundraising by the entrepreneurs to the lead financier. The rationale is that the ensuing dilution increases with the size of the option group.
Providing an option for dilution:
Dilution is an outcome of the option pool’s creation. It is because a portion of the total stock ownership will come from the option pool, which means that the other equity holders’ total stakes must be decreased to make room for this new equity.
The size of an employee option pool should neither be too vast nor too little to prohibit the firm from recruiting top talent. There isn’t a “one size fits all,” though. The needs of each company and the state of the market will influence the degree of diversity.
Remember that after firms reach Series B or C rounds of funding, they often don’t need to expand their option pools as quickly post their valuation stage.
There are a few other things to consider yet:
Valuation: Update your valuation each time the value of your stock changes.
Investors: Add new investors to your cap table as they come along.
Reserve stock: If you offer stock to your employees as a benefit, update the number of shares when new hiring is made.
To make quick and informed judgments regarding the company’s stock, it would be ideal to have a cap table that is well arranged. Make sure you arrange and keep up the cap table and the information updated to make the cap table more helpful for potential investors. Additionally, using cap table software to maintain and update the table is better when compared to a conventional excel cap table.
The workforce is an essential resource for any organization, more so in the early stages. One of the best ways to create a cohesive team and positive workplace culture is through an employee stock option plan or ESOP. Your ambitions for future employees and exponential business growth may or may not succeed depending on how well your ESOP is laid out. Therefore, spend some time articulating your strategy for potential employee stock option pools, particularly concerning how you want the choices to accrue.
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