If your startup were a Netflix series, the cap table would be the credits rolling at the end of each episode. For any up-and-coming founder, it's crucial to have a detailed understanding of who owns what at each stage of the business. This is true whether you're doing diligence for raising money or simply incorporating a new business.
The capitalization table, or cap table, provides the information you need for a clear understanding of your company's ownership. In this post, we'll dive into what a cap table is, and how to use it.
What is a cap table?
A cap table, or capitalization table, is a chart typically used by startups to show ownership stakes in the business. It lists your company's securities (i.e., stock, options, warrants, etc.), how much investors paid for them, and each investor's percentage of ownership in the company.
A cap table is the place of record for the equity-based transactions of a company. It includes ownership stakes, types of shares, and option pools. Ownership stake refers to who (founders, investors, or employees) owns what amount of the business. This reflects who has control over the company. Since most startups need voting agreement among both common and preferred shares, this view shows who needs to sign off on major company decisions (e.g., company sale or reorganization).
The types of shares indicate who has common shares with no special treatment, versus who has preferred stock. Preferred stock typically can often be converted to a 1x payout of money invested. This "money-back" provision protects investors in the event of a sale at a lower valuation.
Debt that can convert into equity is the other type of transaction often found on a cap table. This convertible debt is factored into all ownership calculations on a fully diluted basis. Calculating on a fully diluted basis is a way of looking at ownership where all outstanding warrants, options, and convertible notes are exercised.
As the columns move from left to right, additional dilution items are applied to get an understanding of a person's true ownership percentage of the company.
You'll notice the cap table lays out the essential pieces of a transaction:
Shareholder name as it appears on the security
Date of issuance
Number of shares or units issued
How to Use a Cap Table
1. Understanding your equity
One of the primary uses of the cap table is to show how decisions impact the equity structure of a company. Do you want to expand the employee option pool? Are you raising another funding round?
Either way, you can see exactly what impact that will have on your shareholder groups. When you're raising funding for the first time, you need to know exactly what you're giving up. The cap table will do just that, and show you the proposed new structure of the company.
2. Initial equity distributions
When creating a new company, the cap table is where you put the company breakdown in writing. Discussing initial equity distributions is difficult, but it's a conversation that needs to happen at the formation of every business. Outline distributions to the founding team -- and use the cap table to facilitate the conversation on day one.
3. Managing employee options
When hiring new employees, you want to align their incentives with the objectives of the company. Stock options are a great way to do just that. It gives you a way to match an employee's contributions with the appropriate amount of stock.
The cap table shows exactly how many options are authorized or available to be issued at any given moment. It also lists the number of options used to date. When creating your cap table, you'll want to ensure you have enough options to cover a 12-month rolling period.
4. Term sheet negotiation
Having a clear snapshot of your company's ownership structure enables you to run a what-if analysis on a financing round. Look at what happens to your ownership stake and company control at different valuation levels, and evaluate other factors such as if new options are issued before or after financing. This gives you insight into what situations you're happy with and where to draw your line in the sand.
A cap table isn't a legal document, but rather a snapshot of ownership information used to make decisions. Understanding the information it contains and common ways to use it will guide you on your path -- and make your next big fundraising decision or employee hire a little easier. So, whatever type of episode your startup turns out to be, don't forget to write down the credits.