When founding a company, it’s essential to accurately record and track equity distribution. Most founders do this using a cap table, which can range from a basic Excel spreadsheet to an equity distribution software program. Whatever tool they use for the job, founders need to understand the intricacies of their cap table to ensure their records of equity allocations are accurate and up-to-date.
Cap Table Breakdown
Equity distribution is relatively easy when a startup is in its earliest phases. The partners agree on how to share profits, which is simple enough to track using an Excel spreadsheet. But as the business grows and more people gain equity, the cap table structure becomes more complex and high maintenance. As your business grows, what started as a simple task can morph into a complicated headache. If you’re brand new to cap table management, this article will get you started with the basics: what is a cap table, why do startups need a cap table, and how is a typical cap table structured?
What Is a Cap Table?
A capitalization table — usually called a cap table — is a document that records and tracks the changes in the equity structure of an operating business. It tracks activities such as funding rounds, stock issuance, share cancellations, transfers, exercising options, etc. Your cap table also includes details on company shareholders, stocks issued, the date of issue, the vesting date, and the expiry, as well as data on the total exercised stocks and the option pool. Essentially, your cap table is a live record that every founder needs to understand, as it shows how much of the company each individual owns at any given time.
Cap table management requires recognizing who owns what portion of the enterprise and constantly revising the document and making it available to all parties involved. It’s often a rigorous procedure of updating, tracking, and ongoing communication with all involved parties.
What Does a Startup Cap Table Contain?
Typically, a cap table structure involves listing stakeholders on the Y-axis of aa spreadsheet’s Y-axis and the securities’ details The exact structure of your cap table will vary depending on your company’s requirements, which could range from a more detailed list of shareholders to a more general categorization of them as founders, investors, or employees. Similarly, security information may be condensed into categories such as preferred shares, convertible notes, and so on.
Depending on the size of your company, its growth stage, and the ownership structure, you’ll select the most suitable method to construct a cap table. However, here are some of the essential components that a cap table typically must contain:
- Shareholders’ names
- The number of shares owned by each shareholder
- Ownership percentage
- Share Price
- Outstanding shares
- Stock options that are available for new issuance
- Option pool
Usually, founders are listed first. They’re followed by executives, then employees holding stock, and then finally external stakeholders such as angel and venture capitalists. You can easily tailor your cap tables to meet the needs of your business, depending on your team’s capacity to keep it updated.
Why Do Founders Need a Cap Table?
Cap table management for startups is a critical responsibility for any business. But keeping a comprehensive record of shareholder data isn’t just a standard requirement. Careful review of a firm’s cap table can uncover details that can help guide your company’s future. Here are a few of the key situations that rely on your cap table data:
- Depending on the kind of stock ownership, shareholders are awarded the privilege of voting rights, which could have major effects on management choices. Looking at your capitalization table structure can help you determine which investors should be included as decision-makers in important company matters.
- The details of your authorized, outstanding, and unissued shares and any options and equity are all kept in your capable. This data is necessary to gauge your company’s value correctly and attract potential investors. Therefore, it’s vital to keep an up-to-date cap table to help ensure that you’re attracting the right investors.
- Every startup cap table must include an option pool, which provides you with an idea of how much equity you can use to incentivize new hires. This part of the cap table is especially important in the early stages of your company, as it helps to make up an attractive salary package. As the company grows and employees come and go, the options pool keeps track of equity that can be used to bring in new personnel.
- A company’s cap table provides a glimpse of the amount of equity held by its stakeholders, which is extremely useful when determining if your business can handle dilution — if the need arises.
Cap Table in Different Stages of a Startup
Founders may feel like they have done their research when it comes to startup management, but true understanding comes from experience. Managing a cap table is an important part of a startup’s journey. It’s not enough to simply understand what it is and what it does — you must implement the right strategy at different stages of your company. Here’s a simple breakdown of how startups typically manage their cap tables at different stages of development:
- First stage: At the beginning of any startup, a great, scalable concept is the basis. If the founder is working together with a partner, creating a formal capitalization table usually isn’t essential right away. If there are multiple founders who are providing both money and non-monetary contributions, they need to talk about the distribution of shares and the timeline for vesting. To ensure that the agreements are recorded, it’s recommended they draft a straightforward agreement keeping a record of these early-stage decisions.
- Second stage: After your business is formally set up, managing a formal cap table comes into play. This can be done with a simple Excel sheet, or with a cap table software platform specifically designed to make cap table activities easier and more intuitive. It’s also advisable to seek advice from a lawyer during this step, as the content of a cap table could change based on industry and market demands.
- Third stage: By the third stage of development, startups often have limited cash flow, meaning they often rely on offering equity to help with employee recruitment. Employee equity has become a popular tool for hiring, retaining, and motivating workers. It ties the financial interests of the employee to those of the company, which can encourage better performance. However, it also makes your cap table structure more intricate, as it begins to include various share classes and vesting schedules. It’s extremely important that employees receive their equity benefits in a timely or transparent manner — or you can hurt your employees’ willingness to stay with the company.
- Fourth stage: This is usually where money from both angel investors and Venture Capital sources comes in. It usually comes in the form of seed money or series funding (Series A, Series B, and Series C, and so on). Seed investments often begin at around 250K. After this, Venture Capitalists take the reins in backing the venture. By the time a startup gets to Series B funding, it’s usually grown into a business valued at multiple millions of dollars, with plans to expand globally. Then, Series C financing is used for specific expansion and acquisition plans. No matter which stage of financing you’re in, all investors have similar essential considerations: stability in the startup’s ownership structure, liquidity, liability, etc.
The moment you decide to begin a formal cap table in Excel or using cap table software, it must be properly managed and kept up to date. If your cap table is outdated or doesn’t reflect the true value of ownership, investors will be reluctant to join your venture, and employees will have less trouble changing jobs if they can see a more reliable future elsewhere.
Essential Cap Table Vocabulary for Startup Founders
No matter the type, size, and stage of a business, there are certain terms and concepts which are essential for founders to know so that they can manage their cap table effectively.
Pre-money valuation/post money valuation: The pre-money valuation of a business is its worth before any additional capital comes into play. Before investments are finalized, negotiations between company stakeholders and investors help determine the most suitable pre-money valuation for the company. The post-money valuation, on the other hand, is the worth of the business after the new money is invested (this value is normally higher).
Common stock: Each common stock represents a share of ownership in the firm. Founders and staff own common stocks and have the right to vote on significant managerial decisions. On occasion, they may also be qualified for dividends. However, common stockholders are the last to get paid in the event of a liquidation or a payout.
Preferred stock: This kind of stock is seen as a relatively safe investment. That’s because when a company is dissolved, the holders of preferred shares are the first to be given money and a share of the profits. Unlike common shareholders, they do not have the right to vote.
Convertible notes: These notes act as loans, but they can be swapped for equity once the company reaches a predetermined milestone. With convertible notes, investors don’t need to determine the company’s value before investing. This is beneficial for startups, as it’s usually a tough job to accurately calculate your company’s worth in the beginning. Convertible notes are regularly employed by seed and angel investors.
Stock Options: Employee stock option plans provide a contractual benefit that grants the right to acquire a certain amount of shares at a predetermined cost on a certain date. These are not stocks themselves, but rather options for acquiring them. This discounted rate is also known as the ‘strike price’ and is only available to employees.
Warrants: Warrants are similar to stock options in that they give the holder the right to purchase a certain amount of stock at an established cost by a certain date. However, while stock options are typically granted to employees and other people who work for the company, warrants are used in business deals.
Restricted stocks: Also known as letter stocks or section 1244 stocks, restricted stocks are often used in executive compensation plans. These stocks can’t be transferred, and usually have limitations on when they can be sold. To encourage long-term commitment from key executives, they are subject to a graded vesting schedule lasting several years.
Authorized shares: The amount of shares a public company is allowed to issue is called authorized capital stock or authorized shares. This restriction is commonly included in the company’s articles of incorporation and is listed within the capital accounts of the balance sheet.
Fully diluted shares: These are the total number of outstanding shares, including those that could possibly be converted in the future. This number incorporates not only the issued common shares, but also any convertible notes or employee stock options that could be converted in the near future.
Outstanding shares: This represents the total number of shares owned by all shareholders. It includes any blocks held by institutional shareholders and stocks limited to executives but doesn’t include stocks that have yet to be used, which means the value of outstanding shares is not fixed and can change over time.
Dilution: Issuing additional shares beyond those already in the market causes dilution of ownership. Founders can use the cap table to figure out the number of shares already held by different stakeholders (such as staff and investors) to gauge the level of dilution in the firm and plan for future dilution and its effects on current shareholders.
Cap Table Structure
Maintaining an accurate cap table and keeping all interested parties informed is a major responsibility. At the onset, it may be possible to do it manually, but as the business grows, new stakeholders join, and some leave, it becomes an intricate task with a high potential for human mistakes. Let’s review the two major ways to manage cap tables: Excel sheets and cap table software.
Find out how Astrella cap table management solutions help you easily manage ownership to secure a more successful future for your startup.
Using Excel Sheet for Cap Table Management
A typical approach for startups is to maintain a basic cap table structure in an Excel sheet. This is a good option for startups because they have few employees and little equity to worry about. Plus, Excel sheets are incredibly versatile, allowing companies to tailor their cap table to their specific needs.
However, the complexity of keeping track of equity ownership increases as more investments and hires come on board. Eventually, it becomes necessary to switch to equity management software. At some point, a spreadsheet-based cap table simply can’t handle the expansion of a business. The growth of your business is exciting, but it can also increase the opportunity for errors in your cap table, which can have serious legal consequences. To help your company avoid these legal troubles, you must involve a law firm that will ensure you adhere to IRS and SEC regulations.
The Benefits of Using Cap Table Software
Cap table software provides an incredibly convenient and user-friendly experience when compared to Excel sheets. Even if your business isn’t complex from the start, it’s better to employ cap table software immediately so that all equity operations are efficient from the beginning. Also, your top investors will most likely choose to work with enterprises using cap table software, as it’s much better at giving an up-to-date and accurate view of ownership.
Excel vs Cap Table Software
Given the limitations of cap table management with Excel spreadsheets, the biggest benefits of using equity management software are:
- Significant cost and time savings: Investing in cap table software not only covers the cost of the license itself, but it also lessens the amount of money spent on finance and legal professionals, communication between stakeholders, and the risk of fines due to manual errors.
- Automations: Cap table software eliminates the need for manual updating and tracking of each step after a company’s valuation, new stock issuance, or liquidity. It’s programmed to update the records and notify the stakeholders according to their equity possession.
- A single source of truth for equity ownership: Cap table software acts as a centralized source of information which is easily accessible to all stakeholders. Everyone can have their own personalized account, meaning that the data is always up-to-date and accurate. Unlike cap tables on Excel sheets, which different users can alter, software provides a standardized version that can be customized to suit the needs of each user.
Manage Your Startup’s Cap Table With Astrella
Astrella’s cap table platform is a secure, intuitive solution designed to manage equity and shareholder information easily. It allows for easy tracking of equity ownership, and is equipped with a customizable interface that allows users to access all relevant information in an organized manner. Try a demo to see how Astrella simplifies complex cap table management for startups.
