What is a Cap Table?

Launching a startup is much more than a brilliant idea that might disrupt an entire industry. It is an undertaking that involves an inordinate number of legal, financial, and other documentation that the founder(s) must be aware of and pay attention to. One of them is the capitalization table, simply referred to as the cap table. While it’s not a legal document, it’s nonetheless a document that contains crucial information for both founders and investors.

Cap table defined

Investopedia defines a cap table as “a spreadsheet or table that shows the equity capitalization for a company.” In practice, it’s a spreadsheet that shows who owns what in the company.

Basically, each row in the spreadsheet may contain the name of a shareholder, how many shares they have in the company, and what percentage of the company those shares represent. It sounds simple, but, in reality, a cap table becomes very complicated over time.

Drafting a cap table

Experts advise that founders use existing resources to draft their cap tables. Many law firms provide templates and documents that explain the ins and outs of cap tables. Founders are also advised to familiarize themselves with the basics of record keeping.

What to include in a cap table

The cap table should lay out ownership stake, type of shares, and convertible securities at the very least.

Ownership stake is the size of the business that each founder, investor, or employee owns. It could be 100% owned by the founder, otherwise, this section will contain the names of the shareholders and the number, type, and value of their shares. In other words, their percentage ownership stake.

There are two types of startup shares: preferred shares and common shares. Preferred shares are usually issued to investors, and founders and employees usually receive common shares. Preferred shares provide protective provisions and liquidation preferences to investors to protect their investments. Preferred shares confer different rights in different situations. 

Common shares allow employees to participate in the financial returns of the company, and is often used to recruit and retain top talent. Common shares cost less than preferred shares because they don’t confer special rights and privileges like preferred shares.

Debt that can convert into equity is also included in a cap table. Convertible debt is an established way that early-stage startups use to raise money rather than a traditional equity funding round.

A cap table should also include the total number of authorized, outstanding, unissued, and reserved shares.

Valuation details of the most recent funding round are also important and should include the pre-money valuation, amount of new equity raised, the price per share, and the number of shares.

Why does the cap table become complicated?

Cap tables tend to increase in complexity over time due to the impact of financing rounds and other factors. AngelListVenture gives the following examples.

• All preferred shares don’t confer the same rights and privileges. Simple Agreement for Future Equity (SAFEs) and convertible debt can provide different privileges, including different valuation caps, and different liquidation preferences, or anti-dilution provisions. These must be specified and can affect the cap table. 
• A poor funding round can trigger the anti-dilution protection of previous investors.
• Sometimes startups raise funds through bridge rounds using convertible debt. Since convertible notes are typically repaid with equity, bridge rounds affect the values in the cap table.
• The employee option pool may change and be expanded. The stock options offered to new employees may not be granted at the same strike prices as those for previous hires.
• Employees may exercise their stock options and convert them to shares, in which case they will appear in the cap table as shareholders.
• When employees leave before their options are vested it will also affect the cap table.
• Shares may no longer belong to a shareholder having been transferred to a trust, for instance.

How founders use the cap table

1. To thrash out initial equity distributions

According to Silicon Valley Bank, discussions about how to split a startup’s equity among founders can be so emotionally charged that founders avoid the topic altogether. As soon as equity is divided between two or more founders, the cap table must reflect it. The cap table is used to reflect the contributions each founder made to the founding of the company. The one who came up with the original idea might command a greater share, but it’s not that simple. Founders may disagree on the value of their contributions and how it should reflect in the cap table. This is why equal distribution remains the most popular solution.

2. Get a clear picture of the equity situation

The cap table is the one document that clearly shows how various decisions will impact the company’s equity structure. For instance, you can see how expanding the employee option pool or raising another funding round will impact your various shareholders.

For early startups raising capital for the first time, the cap table can be an effective protection against the temptation to sacrifice too much equity in return for money. The cap table will show how a funding round can affect the company’s structure.

3. To raise funds

The cap table provides valuable information to boost a startup’s chances when entering a new funding round. The cap table tells investors how the company’s ownership is structured and what changes have taken place since the previous financing rounds.

The cap table will inform new investors about previous investments and investors. This is important for new investors who want to avoid situations that may cause them to clash with previous investors. They can also see from the cap table what their liquidity situation is – they want a high liquidity situation so they can receive their money back before other investors, should a liquidity event occur.

A liquidity event is an exit strategy, like an IPO or an acquisition of the venture by another company or a private equity firm. In this case, founders and investors cash in their shares.

4. Hiring and retaining top talent

Stock options allow employees to own part of the company they work for. It helps to retain top talent and keeps them motivated to continue helping the company to excel. At the same time, stock options are a great incentive for top talent to join a business.

Employee options have become standard in startups. The option size is often negotiated between founders and the lead investor using the cap table to determine exactly how many options are authorized or available to be issued at a particular time. The cap table will also indicate how many options have been used so far.

5. Proof of tax and regulation compliance

Cap tables are a record of equity ownership. As such, authorities use them to see if the company, its employees, and investors are paying the taxes they owe. It’s important to keep the document up to date, so the company and its employees are paying the right amounts of tax. If it is not kept up to date, the company or its employees may inadvertently pay too much tax. The document can also reveal if the company has been paying too little tax.

6. Selling the company

The founders consult the cap table to determine how the proceeds of a company sale should be divided among the shareholders. The cap table stipulates what amount each shareholder gets from the sale and in what order. The cap table also prevents disagreements and lawsuits by providing a complete history of the company.

How investors use the cap table

For investors, the cap table serves as an important due diligence document. It provides them with the following key information.

• From the cap table, investors can determine what stake the founders hold in the company. The larger their stake, the higher the likelihood that they are very invested in the company and will work hard to make it succeed. When the founders are left with little equity after multiple funding rounds, it might raise a red flag for investors. Basically, investors want to be sure that founders own a big enough share.
• The cap table can be a warning of upcoming dilution. If there is, for instance, evidence of considerable convertible debt or SAFEs on the cap table, it could indicate future dilution of an investor’s holdings, which may be something to look into further.
• The cap table reveals how diluted the company is. If investors are receiving 10,000 shares, what percentage of the company is it? That percentage will impact their return on investment, so it’s important to know.
• The cap table reveals the size of the employee option pool. If it is substantial, the startup can attract and retain top talent, which is crucial for the future growth of the startup, especially if it plans to scale fast.
• The cap table is a record of who all the investors are and what percentage of the company they own. The identities and ownership stakes of the other investors can have a negative or a positive effect on new investors. The cap table reveals how many investors there are. Mostly, a large number of investors may be a problem as it dilutes the stakes and complicates negotiations.
• Ultimately, a cap table can help investors decide how much to invest. They could, for instance, do various calculations based on the Pro-forma capitalization tables to estimate how much they should invest.
• Information in the cap table can tell investors if the company has enough equity left over for new investors in later rounds.
• The cap table tells investors how ownership is divided among the founding team. Investors prefer equal ownership and are apprehensive when equity is not distributed equally, because it can signal conflict at a later stage.

What is a Pro-forma capitalization table?

A Pro-forma capitalization table comes into play when calculating the effect of a funding round on the subsequent value of the startup. This version of the cap table shows how the ownership in the company would change after a funding round is completed. The parties use it to see how everyone’s stake will be affected by the financing round.

Maintaining a cap table

Founders need to keep the cap table up to date. Several events during the lifetime of the startup can change the figures in the cap table, including new investments, issuing new shares funding rounds, and increasing or decreasing stock options for employees.

Also, when key shareholders leave or transfer shares to another shareholder, or employees are terminated or retire, the company must update the cap table.

As mentioned earlier, the cap table is an important due diligence document for investors, and tax and regulatory authorities will demand insight into those figures.

Here is a suggested list of facts and figures that need to be kept up to date.

• Company valuation changes – make a note whenever your stock price changes.
• Add new investors to your cap table.
• Record transfer of shares between shareholders, repurchase of shares.
• Whenever you offer stock to employees, update the cap table indicating the number of shares.
• Detail debt that has been converted to equity.
• Record when new shares have been issued.
• Record total outstanding shares.
• Record remaining authorized shares.

Final thoughts

The value of a well-maintained cap table increases over the lifetime of a startup as more and more information is added to it. In the process, the cap table can become a complicated document. It is prudent to draft a cap table right at the start of the venture and to maintain it properly throughout. An updated cap table helps founders and venture capitalists make informed decisions based on the information reflected in the cap table.