Image credit: Unsplash
- A capitalization table is a list, spreadsheet, or table, listing all of the equity (or securities) that your startup issued and to whom. Your cap table will identify the securities issued, whether preferred or common stock, warrants, or convertible notes. Additionally, it will show how much each shareholder owns.
- The cap table also lists how much each investor contributed to your startup for each funding round. Finally, the cap table shows the startup's current valuation and reflects the current number of outstanding shares.
- A cap table is essential for raising investment funds, as it shows potential investors how the startup is owned and how ownership changed with previous investment rounds.
- As a startup, you may want to create an option pool for employees and strategic advisors. To do this, you’ll set aside common stock shares, reserving them for key talent. Once you’re ready to reward these employees and advisors, you’ll grant the reserved stock options accordingly.
- Although an option pool contains stock options, or the right to purchase stock, these options can still impact the startup’s cap table and therefore must be listed on it. For example, even if the option holders have not exercised their right to purchase stock, the eventual impact of such an exercise will dilute the current shareholders’ equity positions.
- Cap table management is critical to the overall success of your startup. This management can often be overwhelming, especially to a first-time founder. For example, the cap table is not just the table itself, but also reflects stock issuances, cancellations, and exercises to options.
- Once a founder understands the cap table's scope, they need to understand what’s required for prudent management, including executing legal documents, communicating with shareholders, and complying with regulations.
For startups, capitalization tables (“cap tables”) serve a critical function. A cap table identifies and shows the ownership of your business typically reflected on a table or a spreadsheet. However, the purpose of these tables goes beyond just identifying your ownership.
A cap table is essential for raising investment funds, as it shows potential investors how the startup is owned and how ownership changed with previous investment rounds. Additionally, in many countries, such as the United States, “cap tables are used as a formal legal record of equity ownership.” This guides the Internal Revenue Service and other tax authorities on who must pay taxes and how much they should pay. The cap table is also instructive when founders decide the sell their business. The sale proceeds are divided according to the cap table.
For all these reasons, it’s critical for founders to continuously update their cap tables, making sure they properly reflect the startup's ownership. In this article, we’re going to break down capitalization tables, giving you tools to create one of your own.
Cap Table Definition
A capitalization table is a list, spreadsheet, or table, listing all of the equity (or securities) that your startup issued and to whom. Your cap table will identify the securities issued, whether preferred or common stock, warrants, or convertible notes. Additionally, it will show how much each shareholder owns.
The cap table also lists how much each investor contributed to your startup for each funding round. Finally, the cap table shows the startup's current valuation and reflects the current number of outstanding shares.
How to Create a Cap Table with Option Pool
As a startup, you may want to create an option pool for employees and strategic advisors. To do this, as the founder, you’ll set aside common stock shares, reserving them for key talent. Once you’re ready to reward these employees and advisors, you’ll grant the reserved stock options accordingly.
Note, the option pool contains stock options, not straight or restricted stock. An option gives the holder the right to acquire a share of stock in the startup at a specific time. Typically, the option holder can purchase the stock at a lower price than fair market value, giving the holder financial incentive while allowing the founder to reward and retain key employees and advisors.
Although an option pool contains stock options, or the right to purchase stock, these options can still impact the startup’s cap table and therefore must be listed on it. For example, even if the option holders have not exercised their right to purchase stock, the eventual impact of such an exercise will dilute the current shareholders’ equity positions.
Although each current shareholders’ number of shares would not change, once the options are exercised and stock is purchased, the total number of shares held by shareholders is greater, thus altering the percentage of stock owned by each shareholder.
Let's look at a capitalization table example. The first chart shows a hypothetical cap table for a startup before creating an option pool for employees and strategic advisors.
Chart by Plan Projections
Now, the startup creates an option pool consisting of 20,000 stock options. Here is the impact the options have on the cap table.
Chart by Plan Projections
According to Plan Projections, “the effect of granting the stock option is to dilute the percentage shareholding of the existing shareholders. Although the number of shares held by each existing shareholder has not changed, the total number of shares including the stock option is now 1,020,000, and therefore the percentage ownership of each shareholder reduces.”
Cap Table Calculator
When you’re creating your cap table and preparing for raising capital, one tool that would be highly beneficial is a cap table calculator. These calculators can help you adjust your cap table, identifying who owns which shares after an investment round. Further, you can “[m]odel your cap table through multiple investment rounds,” projecting the impact on your cap table. Finally, you can model dilution results if you add employee option pools or convertible loans.
Some of the top cap table management tools offer calculators, such as Ledgy and Captable.io, helping you to model different scenarios impacting your cap table.
Cap Table Management
Founders often launch a startup because they have created a solution for a pain point in the marketplace. However, as their startup grows, founders will need to “manage their business needs to evolve to enable strategic decisions for growth.” One of these management tasks involves the cap table.
According to TechCrunch, “[f]or a first-time founder, it can be overwhelming to develop a cap table and make all related decisions. However, with the right resources and adoption of best practices, founders can better manage, maintain and leverage their cap table to provide actionable business intelligence and management.”
Proper management of a cap table goes beyond the cap table itself. According to Morgan Stanley, “[i]n reality, a cap table is made up of many transactions and legal documents. A few examples of these might include stock issuances, sales, transfers, cancellations, conversions of debt to equity, [and] exercises of options.”
Once you understand the scope, then you need to understand what’s required for prudent management. For example, “[c]ap table management is accurately and effectively managing all these complexities. This entails drafting and signing legal documents, recording transactions, communicating with shareholders and complying with regulations among other things.”
What is the best way for a founder to approach cap table management? Here are some key points to consider.
- Familiarize yourself with your startup’s cap table, including the type of equity offered.
- Implement tools to help manage the cap table. As we noted in a previous post, “[a] good system will enable you to centrally track and manage who holds equity and has the right to exercise equity in the future covering transactions like exercise of options, cancellations, conversions of debt to equity, transfers, and stock issuances with legal compliance.”
- Stay compliant. A critical part of your cap table management is tax and regulatory compliance. You’ll need to be familiar with regulations such as those pertaining to incentive stock options (ISOs), Internal Revenue Code 409A (which requires a formal valuation annually to determine the strike price of options), 83(b) elections (which affects restricted stock), and Rule 701 (which governs when you must register with the Securities and Exchange Commission).
- Update your cap table as needed. Because your startup is constantly evolving, from multiple funding rounds to issuing stock to attract and retain talent to shareholders cashing out their interests, you must continually update your cap table showing these changes. It’s critical to keep your cap table current and up-to-date, as many strategic business decisions will be made based on the cap table. If it isn’t current, your choices won’t be backed by your startup’s most recent data, potentially creating problems as you grow.
- “Keep everyone on the same page.” Ensure all founders and key employees are rowing in the same direction as investment rounds and company growth. This synergy will be reflected on the cap table.
- Bring in professionals when needed. As the cap table is the core of your business, don’t hesitate to get professional advice from accountants and lawyers.
According to Morgan Stanley, “[a]t the end of the day, cap table management is all about legal claims to the assets of the company, so you don’t want to take shortcuts. It’s pretty straightforward when you start out, but things can get complicated quickly ... Founders and startup employees have a lot at stake when it comes to their equity, so take the time to understand the legalities and the economics of your cap table. Next to building a great company, your cap table might be the most significant contributing factor in the creation of wealth for entrepreneurs.”
Capitalization Table Template
Now that we’ve walked through the ins and outs of capitalization tables, let’s take a look at two sample cap tables.
Image by CFI. If you’d like to explore more templates, visit CFI’s website, which has numerous templates for startups, including the cap table above.
In this second example, you’ll notice that the two types of investment rounds (i.e., Series Seed and Series A) are added as well.
Image by TechCrunch.
Learn more with us
- How to prepare an income statement
- How to make a pro-forma income statement for a startup
- How to create a balance sheet for a startup business
- Top 5 accounting software of 2021
- What does ARR (Accounting Rate of Return) mean?
- Learn more about accounting for startups
Access more guides in our Knowledge Base for Startups
We can help!
At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most — your business.
If you're looking for help in creating or managing your startup’s cap table, we help by overall shepherding the process to ensure you know your next steps, get in touch with us.
Like our content?
Subscribe to our blog to stay updated on new posts. Our blog covers advice, inspiration, and practical guides for early-stage founders to navigate their startup journeys.
Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.