Capitalization Table (Cap Table)

A capitalization table, commonly referred to as a cap table, is a detailed spreadsheet or ledger that tracks the equity ownership of a company. It records the total number of shares that have been issued, who owns them, and what type of shares they are.

A cap table serves several key purposes:

• It provides a full accounting of a company’s shareholders - founders, investors, employees with stock options, etc.
• It shows the equity stake percentages of each shareholder. This indicates levels of ownership and control.
• It details the various classes of shares (common, preferred, etc) and rights attached to them.
• It tracks equity dilution over funding rounds as more shares are issued.
• It helps value a company by showing the total shares outstanding.

Cap tables also serve as a formal legal record of equity ownership, crucial for tax and regulatory compliance, ensuring companies meet their obligations and avoid penalties for tax mistakes.

At its core, a cap table contains:

• Names of the shareholders
• Number and class of shares held by each
• Percentage ownership of the company
• Share price and value

Additional details like vesting schedules, liquidation preferences, and voting rights may also be captured in an extensive cap table.

Keeping this record up-to-date is critical as a company’s capital structure evolves over time. Cap tables help maintain alignment between founders, management, employees, and investors on equity stakes.

Importance of Cap Tables

A cap table serves several critical functions for a company:

Understanding the difference between accounting ownership and economic ownership is crucial when analyzing a cap table. Accounting ownership refers to the actual ownership percentage of individual shareholders, directly reflecting their stake in the company. In contrast, economic ownership represents the percentage of ownership available to equity, highlighting the potential financial benefits shareholders might receive. This distinction is essential for accurately tracking equity ownership and understanding the nuances of shareholder rights and potential returns.

Tracking Equity Ownership Stake

A cap table serves as a record detailing the ownership of shares in a company and the percentage of ownership held by each individual. As a company issues shares through means like investment rounds and stock options, the cap table needs to be regularly updated to reflect changes in shareholders and ownership stakes. An accurate cap table is crucial for determining who owns equity in the company and in what proportions.

Facilitating Fundraising and Investment Rounds

When raising funds or considering liquidity events, investors closely examine a company's cap table to understand the distribution of ownership and assess the value of their investment. They seek information on shareholders, equity retained by founders/management, and how subsequent funding rounds may impact ownership percentages. A maintained cap table helps build investor confidence by showing that the company has organized its equity structure effectively.

Ensuring Compliance with Regulations

Keeping an updated cap table isn't just a practice. It's a requirement. The SEC mandates that private companies record all stock issuances and transfers. Failure to maintain cap table records can pose risks during processes like going public or being acquired. It's also important for tax reporting purposes.

Creating and Maintaining a Cap Table

A cap table should contain all the relevant information needed to track a company’s ownership structure and equity distribution. At a minimum, it should include:

• Names of shareholders
• Number and type of shares held by each shareholder
• Date shares were acquired
• Price per share
• Vesting schedules for stock options or restricted stock units

Moreover, details such as liquidation preferences, voting rights, and dividend rights can also be outlined for shares, on the cap table.

When founders are setting up a cap table it's advisable to begin with a spreadsheet or utilize a cap table template to kickstart the process. Known platforms such, as Carta, Eqvista and Capshare offer made cap table templates that automatically crunch numbers like dilution and ownership percentages. These tools also include collaboration features to securely share cap tables with stakeholders.

Basic spreadsheet programs like Excel can work initially but have limitations in modeling complex equity structures. As a company grows, using dedicated cap table software provides more accuracy, automation, and access controls. It's important to keep the cap table data secure allowing access to management individuals like the CEO, CFO and General Counsel.

Regularly updating the cap table to reflect new issues, exercises, repurchases, and cancellations of shares is critical. The cap table should be reconciled on a basis and before initiating any new funding rounds. Involving experts helps ensure compliance with regulations.

Pro Forma Capitalization Tables

A pro forma capitalization table, also known as a forma cap table is essentially a projected or hypothetical version of the company's capitalization structure. While a standard cap table provides the ownership breakdown of the company, a pro forma cap table illustrates a future capital structure based on assumptions about upcoming events such as new funding rounds stock option exercises, or other dilution scenarios.

Pro forma cap tables enable companies and investors to simulate how possible future financing events could impact them. For instance, founders can use a forma cap table to visualize the dilution in an upcoming Series A round. Investors might ask for a projected cap table to understand how their ownership stake could change in investment rounds.

Some common use cases for pro forma cap tables include:

• Modeling the impact of a planned funding round
• Projecting ownership changes if all options were exercised
• Demonstrating dilution effects over future rounds
• Forecasting potential exit values based on assumed valuations
• Evaluating the impact of different financing scenarios
• Structuring future rounds to retain control or hit targeted ownership levels

Pro forma cap tables enable stakeholders to make more informed decisions by visualizing the potential outcomes of key events. They provide a forward-looking analysis tool to complement the official record of a company's current cap table. Both founders and investors can gain valuable insights from walking through various pro forma scenarios.

With careful assumptions and scenario modeling, pro forma cap tables help companies plan their financing strategy and allow investors to anticipate their potential equity positions. While not a binding document, pro forma cap tables give all parties a clearer picture of the target cap structure for future rounds.

Cap Table Changes Over Time

As a company grows, its cap table undergoes changes during Series A funding and subsequent rounds where venture capital plays a vital role. Let's take a look at how cap tables evolve as a company progresses.

Seed Stage

Initially, the cap table mainly shows the ownership percentages of the founding team and any initial angel investors. For instance, founders could hold 80% of the equity while early angels own 20%.

Series A

When VC investors provide Series A funding, the founder's ownership shares often decrease due to dilution. In this scenario, VCs might own 20% and founders may have 60%. The remaining 20% is set aside for an employee stock option pool.

Series B, C, etc.

In subsequent rounds, the cap table continues to evolve. More shares are issued to new investors, decreasing the ownership percentages of existing shareholders due to dilution. The option pool may also expand to attract talent.

IPO

If the company pursues an IPO, the cap table will reflect the conversion of preferred shares to common shares. New shares will also be issued and sold on public markets. The cap table now represents fractional ownership of a public company.

M&A

In an acquisition, the cap table helps determine payouts based on liquidation preferences and other terms. The cap table provides clarity on deal terms and who gets what portion of the proceeds.

Tracking these changes over time provides a historical record of the evolution of equity ownership. Periodically generating updated cap table reports is crucial for understanding the implications of dilution.

Special Considerations

As companies grow, their cap tables can become more intricate when dealing with equity structures like stock options, warrants, and convertible notes. It is crucial to ensure the accuracy of recording stock ownership in the cap table to reflect complex equity instruments like stock options and warrants accurately. This not only helps in maintaining a clear record of equity ownership but also complies with legal requirements for tracking stock ownership.

Complex Equity Structures

In addition to straightforward common stock, a cap table must accurately reflect more complex equity instruments like:

• Stock options - Options granted to employees, advisors, etc. Each option grant is recorded with the number of shares, strike price, and vesting schedule. Unexercised options are considered "on top" of the cap table.
• Warrants - Similar to options, but issued to investors. Warrants give the holder the right to purchase shares at a set price in the future.
• Convertible notes - A type of debt that converts into equity shares in later rounds. The conversion terms must be incorporated into the cap table.

As these options and instruments are exercised or converted, the cap table must be updated to reflect the new share issuances.

Tax Implications

The cap table drives important tax considerations like 409A valuations. These independent valuations are needed to set the strike price for stock options. Changes in the cap table can impact the 409A valuation, which affects tax liabilities for both the company and employees receiving options.

Confidentiality

Cap tables contain information regarding equity stakes and ownership percentages. It is crucial for companies to carefully control access, to the cap table and ensure its confidentiality. Investors may require NDAs before being granted access.

Cap Table Analysis

A cap table goes beyond being a record of equity ownership; it serves as a valuable analytical tool offering essential insights through scenario modeling and reporting. By manipulating the cap table, founders can forecast the effects of events and funding rounds. Common cap table analysis techniques include:

Waterfall Analysis

Waterfall analysis involves creating various liquidation scenarios to see how proceeds from an exit would be distributed across shareholders based on liquidation preferences and other rights. By modeling different exit values and dates, founders can see the payouts to common stockholders under various outcomes.

Valuation Analysis

Utilizing the cap table enables founders to derive the implied valuation of the company based on investors' previous investments. Comparing this estimated valuation with projected exit valuations provides founders with an understanding of dilution and guides decisions on how much equity can be allocated in rounds.

Ownership Percentage Analysis

As more shares are issued, ownership percentages change. Analyzing how ownership percentages evolve in hypothetical future rounds helps founders understand the potential equity stakes of current shareholders. This informs decisions around the issuance of options and new shares.

Control Analysis

By looking at voting rights and board seat allocations, the cap table can reveal who controls key decisions. Founders should understand how this control may shift as more investors come on board.

Regularly analyzing the cap table provides vital intelligence, empowers negotiations, allows more strategic planning, and enables founders to make decisions from a position of strength rather than desperation. Turning the cap table into an analytical tool is key.

Best Practices and Tips for Cap Tables

Maintaining a current cap table is vital for any company issuing equity as it plays a role in managing and comprehending each party's stake in the company. Below are some recommended practices;

Keep Cap Tables Current

Update the cap table promptly whenever there are changes in equity ownership such as issuing stocks, exercising options/warrants, converting notes, or transferring shares. Don't let administrative backlogs build up. Record each transaction as it occurs to avoid errors.

Review Regularly

Schedule periodic reviews of your cap table - quarterly or bi-annually. Scrutinize the cap table details closely to spot any discrepancies or inconsistencies. Verify totals are correct and match supporting documentation. Having multiple sets of eyes review is ideal.

Seek Professional Advice

Work with knowledgeable legal and accounting advisors to set up and maintain your cap table properly. They can ensure compliance with regulations and help structure more complex instruments like convertible notes. Rely on their expertise rather than trying to manage everything internally.

Maintain Proper Version Control

Save dated versions of the cap table and track changes carefully - don't just overwrite old files. This provides an audit trail and the ability to reference historical cap table snapshots if needed. Use a cap table software that includes robust version control features.

Control Access

Limit cap table viewing access only to essential personnel and investors on a need-to-know basis. Have strong data security measures in place. Get confidentiality agreements signed by anyone provided with cap table information.

Plan Ahead

Anticipate future scenarios when structuring equity grants and investments. Model dilution effects and run waterfall analyses. Think through terms for exercise windows, vesting schedules, liquidation preferences, and triggers. Aim to retain control and minimize dilution.

By following these tips and best practices, you can feel confident in the accuracy of your cap table and its ability to clearly communicate the company's equity ownership details to stakeholders. An organized, professional cap table inspires trust in investors and helps avoid potentially costly mistakes.

Cap Table FAQs

Cap tables can seem complicated at first, leading to many common questions from founders and investors alike. Here are some of the most frequently asked questions about cap tables and capitalization management:

What happens to the cap table when a new investor comes in?

When a company raises a new round of financing, the cap table must be updated to reflect the new shares issued to investors. This causes a a dilution of existing shareholders' stakes. Their percentage ownership decreases as the shareholder base expands.

How do you calculate dilution?

Dilution is determined by dividing the new total number of shares by the number of shares an existing shareholder owns. For example, if the company has 100 shares and an investor owns 10 shares (10% ownership), and then the company issues 20 new shares in a financing round, there are now 120 total shares. The investor's 10 shares now represent 8.3% ownership due to dilution (10/120).

When do you need to involve a lawyer for cap table maintenance?

It's advisable to involve a lawyer when setting up your initial cap table to ensure it complies with relevant regulations. Lawyers can also help with updating your cap table during complex transactions like debt conversions, mergers and acquisitions, IPOs, etc.

How often should a cap table be updated?

Cap tables should be updated as soon as shares change hands, such as after an investment round closes or stock options are exercised. Cap tables should be reviewed at least quarterly to ensure they stay current.

What mistakes do companies make with cap tables?

Common cap table mistakes include:

• Forgetting to update it regularly
• Inaccurate records and math errors
• Failing to account for vesting schedules, cliffs, and terminations
• Not tracking important details like liquidation preferences

Where should cap table records be stored?

Cap tables contain highly sensitive information and should be stored securely. Maintain digital and printed copies protected by encryption, passwords, and limited access permissions.

Who should have access to the cap table?

Access should be restricted to executives, founders, investors, and legal advisors who need the information for defined purposes. Employees and the public should not have open access.

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