Everyone in the startup world knows what a cap table is. It’s what we set our Thursday happy hour drinks on, right?
Okay, so you’re probably not that clueless. But many entrepreneurs still have a misguided definition or limited understanding of what a capitalization table really is. Many inaccurately assume it’s just a spreadsheet that tracks your transactions.
But seriously, what is a cap table?
So here’s the answer to your $64,000 question: a cap table is a record of ownership. It provides an analysis of the founders’ and investors’ percentage of ownership, equity dilution, and value of equity in each round of investment.
What goes into a cap table
Unlike your original business plan, a cap table won’t fit on a cocktail napkin. It’s comprised of many different transactions and legal documents. These might include stock issuances, sales, transfers, cancellations, and conversions of debt to equity just to name a few examples.
As an entrepreneur, you’re tracking countless factors on a moment by moment basis. But your cap table helps you remain current on the things directly affecting your business such as ownership percentage change as stock shares are converted, sold, given to new hires, or vested. It will also help you track how much of the company you own, the number of outstanding shares (by type), the number of shares owned by stockholders, or the number of shares in your option pool (just to name a few of things it will allow you to track).
How to make a cap table
As with most things in the startup world, there’s not an exact science or cookie cutter format to follow when creating your cap table. But to make it easily accessible most people prefer to use an Excel spreadsheet. You could use Google sheets, but not everyone has a Google account. Google sheets also prevent you from using some of the formulas available in Excel.
Creating a cap table can be frustrating and tedious. But remind yourself that this tool will spare you from many headaches down the road. As with any first experiences, there will be a learning curve to setting it up. Your personal preferences will also impact the way that you set up your cap table.
Usually the names of your shareholders are in the left column along with the capital contributions and units in the subsequent columns to the right. In descending order of earliest to most recent list your co-founders and investors separated by rows explaining there class of stock and option. To simplify the process, it might be a good idea to use a sample cap table when creating your first one.
As outlined by Capshare, there are certain terms and formulas you need to be aware of when building your cap table.
Pre-Money Valuation: Value of your company determined prior to investment
Price-Per-Share: Pre-Money Valuation/Pre-Money Shares
Post-Money Valuation: Pre-Money Valuation + Total Investment Amount
Post-Money Shares: Post Money Valuation/Price-Per-Share
Investor Percent Ownership: Investor Shares/Post-Money Shares
Your cap table can become a complex monster very quickly. And as you add employees, take on investors, and make decisions that cause financial disruptions within your company, this table will become even more intricate. Whether you develop your table from scratch or use a software, make sure that you’re able to keep it as simple as possible to prevent any mistakes in your record.
Why your startup should care about a cap table
Unless you’re bootstrapping your startup, your company wouldn’t be where it is if not for investors. Even if you’re completely self-funded at the beginning, there’s a good chance you’ll be required to seek outside funding in the future.
In your early days, your first employees will join your team expecting equity. A cap table is critical tool that will help you not only raise money on better terms, but also hire key employees and remain compliant.
Helps you raise money on better terms
As you negotiate with new investors it’s important to keep in mind the impact it will have on your current shareholders. An organized cap table will help you stay up to date and allow you to negotiate more effectively with potential investors.
Helps you hire and keep key employees
Want a great way to keep your employees motivated? Give ‘em a piece of the pie! One of the most appealing benefits of joining a startup is the opportunity to gain equity in the company.
But your startup employees will want to know what they’re getting into. Until recently, it was common to offer ambiguous details. But today your equity recipients will expect full disclosure as to what their payout will be at different exit values.
Don’t avoid transparency: it doesn’t have to be a negative thing. Consider your cap table one of your greatest tools for boosting team morale. You and I both know entrepreneurs can use a healthy dose of it from time to time!
Helps you stay compliant
If you need any further incentive to create and maintain your cap table it’s the IRS. When it comes to taxation of equity, your Uncle Sam has something to say (and by that I mean, the IRS likes to tax it). A key function of your cap table is maintaining tax and regulation compliance. This is not a corner you want to cut! Failing to remain compliant could result in penalties or higher taxes for you and your employees.
You should speak with your accountant to cover all the taxes and regulations. But there are five common regulations you should be aware of:
- ISO $100k limits specify how many options can vest in a given calendar year in order to qualify for certain tax treatment.
- IRC 409a regulations require a formal valuation at least once a year to determine an appropriate strike price for options.
- ASC 718 (formerly FAS 123R) is an accounting requirement for measuring and recording the expense associated with issuing equity-based compensation.
- Rule 701 is an exemption from being required to register with the SEC in order to issue equity compensation.
- 83(b) election pertains to the tax treatment of restricted stock awards, and it needs to be filed within 30 days of grant.
Helps when selling the company
If you decide to sell your company, a crack squad of lawyers will thoroughly evaluate every last detail of your company. Included in this investigation will be an evaluation of your cap table. It won’t bode well if all you have to show is a spreadsheet you threw together at the last minute. They’ll want to see your shareholder agreements, option agreements, sale agreements, and more.
Your cap table will explain who gets what when you go to sell your company. But incomplete or conflicting information could result in a legal dilemma. And a lawsuit is the last thing you want to worry about when it comes time to sell the company or go public.
How to manage your cap table
You can stay on top of everything and avoid costly mistakes by implementing a few best practices. This isn’t a comprehensive checklist, but it should help you address the most important areas.
- Pick an easy to use platform that allows easy collaboration with everyone who will be involved with the cap table.
- Record convertible notes. If you stay on top of convertible notes it will save you time, expenses and unpleasant surprises when you raise a conversion triggering equity round.
- Keep track of stock options and vesting schedules. Typically, options to buy stock will vest over time, so you need to keep track of how many shares have vested for every option grant. Company employees and your fellow founders will be grateful to have clarity over this.
- Record basic share information such as who the shareholders are, how many shares they have and what percentage of the company they own.
- Develop a central repository. Maintaining a central repository for shareholder reporting and legal documents helps avoid lost documents and conflicting records. It will also make it easier for everyone to access information when needed.
- Keep everyone on the same page by sharing your cap table regularly.
- Don’t over complicate your cap table. It should be easy to understand and self explanatory with the supporting documents and commentary where needed.
- The founder should ultimately be responsible for the cap table. If the responsibility of the cap table maintenance is given to someone else, the standards and expectations should be clearly defined.
- The cap table allows your to keep track of your shareholders’ information. Investors and employees should inform if their contact information changes. This will prevent any delays during a merger of IPO.
- If you see a problem on in the cap table, fix it immediately. These mistakes will only compound and become more complicated to fix over time.
Avoid common mistakes
At first your cap table will be easy to maintain. But as your company grows, your little collection of numbers can become a monster of spreadsheets and documents that can easily become a major headache. With growth and development (such as a merger) your cap table will require updates and become more complicated in the process.
As the complexity of the table grows you need to ensure you avoid the common mistakes that come with updating your cap table. Upcounsel notes eight common mistakes you should avoid when maintaining your cap table.
- Remember your option pool. “The contents of an option pool may lower the pre-money valuation of your company and dilute stock values.”
- Prevent clutter in your cap table. Instead of trying to cram everything into one table, attach additional supporting documents.
- Ensure a change on one table is reflected across them all. If you change a figure in one table, don’t forget to change it in the others.
- Keep a vesting schedule summary since not all employees may be on the same vesting schedule. Refer to the vesting schedule summary in the cap table.
- Don’t forget to include angel investors in your cap table.
- Continually update your cap table. Your cap table is meant to be added to and amended whenever there are business ownership changes (the buying, selling, vesting and conversion of stock, for example.)
- Keep your cap table organized. An organized cap table will minimize the possibility for mistakes. And if there are mistakes, an organized table will make it easier to identify the mistakes.
- Don’t lump all of your stock into one classification. Break it down appropriately: Series A, B, C, etc. This will make it easier to contact everyone when it’s time to seek additional financing.
The creation and upkeep of a cap table is clearly not the sexiest part of the entrepreneur’s life. But, in the turbulent days of a startup, a well maintained cap table is often what keeps the shit from hitting the fan!
Develop your cap table at the beginning of your startup. As your company grows, continually update it. This will prevent it from getting out of control so you can focus on the growth of your company.