John is an experienced freelance content writer with an eclectic employment history.
A cap table, or capitalization table, is a collection of data that details the equity ownership capitalization for a company. In practical terms, this means you will be able to find each type of equity ownership capital, along with the individual investors and the share prices, at the minimum. Depending on the situation, a cap table may be more complex.
Nascent companies, such as startups, most commonly use capitalization tables to show ownership stakes in the business. Being able to show who has control over the company is especially useful in these early stages. Still, any type of business may find benefit in having a cap table prepared.
The Purpose of a Cap Table
There are many reasons to have a cap table; however, they can all be broadly classified under "decision making." Entrepreneurs and startup businesses must continuously make decisions that rely on accurate capitalization information.
It may be due to looking into new financing options or trying to determine if there are sufficient shares in the option pool to offer a new employee options. Having this information well-organized and accurate will enable these decisions to be made fully informed and quickly.
Definition of Terms
The most common terms you may encounter in the realm of cap tables include;
- Capitalization - The total market value of a company
- Securities - Tradable financial assets
- Equity - The value of shares held
- Shareholder - A person or entity that owns shares in the company
- Convertible Notes - Short term debt that converts into equity
- Dilution - The reduction of value as more shareholders join the fray
Parts of a Cap Table
A cap table will typically include a list of names or groups who are founders, investors, common stockholders, and other entities of that nature. Alongside each name, you will find the information associated with that entity. This will include what they own in terms of types of securities and percentages, as well as when they invested in the company.
There is no standardized format for a cap table, so the exact layout may differ from company to company. Still, by necessity, most cap tables will store the same basic information.
Examples of Information Stored in a Cap Table
As mentioned, the exact information stored in a cap table can reach varying degrees of complexity, depending on the company. However, a basic example of a cap table will typically include the following fields for each entry;
- Stockholder name
- Date of investment
- Number of shares or units held
- Concise commentary stating any critical information regarding this investor.
Cap Tables and Your Investors
Pinpointing exactly what a potential investor looks for in a cap table is no easy feat, as motives will vary wildly from market to market. Still, there are a few common things investors will be on the lookout for when perusing your cap table.
Too Many Cooks
Investors are not typically thrilled to see pages and pages of other investors in your cap table. Having an abundance of investors can be a distraction, and distractions count as a black mark in the eyes of potential new investors. If your cap table is so long that it requires page breaks, you may scare new investors away.
Cap tables allow for some fascinating maths to be carried on out the potential future of a business, and investors are well aware of this and very capable of doing that math or themselves. If your cap table doesn't add up, new investors won't sign. An example of this would be the numbers not tallying up to enough to support the return on investment required for the current investors.
We are all unique, but that shouldn't necessarily translate to a cap table. If your investors all have their own bespoke terms, it introduces a great deal of complexity to the equation, which translates to risk for your new investors.
Cap Tables and Your Employees
With regards to your employees, cap tables serve as a great way to combine incentive and objective. By using stock options as an incentive for employees and potential recruits, you create a vested interest in the success of your business that is shared by more than just the founders or distant investors.
The cap table will clearly show how many options are available or authorized at any given time. As well as how many options have been used up to that point. It provides your employees with valuable information about where the company is at, and what they might be able to strive for. Ambition is a strong motivator; if an employee believes in the company, they will probably be interested in stock options.
Common Cap Table Mistakes
By knowing what the most common mistakes are when handling a cap table, you can infer much of what you should be doing, so let's take a look at some common mistakes.
Failure to Correctly Calculate the Effects of a Financing Round
As we mentioned above, the tales your cap table can tell are visible to all. If you fail to correctly analyze the impact of a round of financing, potential investors who didn't fail to spot that mistake will likely take their money elsewhere.
If you have "lost" any shareholders, the figures in your cap table will reveal it. This tends to happen to lone investors with convertible notes. Similarly, there have been instances where investors who have registered interest but never actually invested have ended up in the cap table by accident. Neither mistake is a good sign to investors.
Being a little casual with date entries can end up costing shareholders when it comes to paying tax. This will not only disgruntle existing shareholders; it will put off future investors.
Cap Table Management
In the beginning, a cap table serves as a handy tool to keep track of equity. As things progress, it becomes a crucial tool for decision making share tracking and generally seeing the bigger picture.
All aspects of a cap table must be kept accurate and up to date for this incredibly useful tool to be effective, whether it is contact details of shareholders, the share subdivisions, or the dates of share transfers. If any of these details are off, your ability to make informed decisions about the future of your business will be off, also.
Dealing With Dilution
In its purest sense, dilution equates to the loss of share value as more shares are made available. For example, if the founding members of a company own 100% of the shares, any successful round of financing will reduce that number. The founders may still have the same amount of shares, but the percentage of the total number of shares will be lower since there can only be 100% in total.
The best way to deal with dilution is to manage it from the beginning. Do not rush into financing rounds, and think carefully about the terms you agree to. Two different terms can leave you with the same amount of shares but considerably less value.
For most startups, however, dilution is an unavoidable reality of success. Do not fall into the trap of assuming bigger is better and essentially handing over your company because the money blinded you.
How to Keep Control of Your Company
It is unfortunately common for founders and CEOs to lose control of their company as funding starts to come in. While dilution may be unavoidable for most ventures, there are things you can do to mitigate the damage. Understanding how to keep control of your company should be considered an essential skill for any entrepreneur.
Bootstrap for as Long as You Can
Don't fall into the trap of holding financing rounds just because it would make life easier. If you can get by without additional funding, try to do so for as long as is realistically possible.
Consider Every Deal Carefully
Sometimes a deal can look too good to pass, and sometimes it really is. Not giving a potential agreement proper consideration before signing the dotted line is a quick way to losing control of your company. Be sure to do a deep dive on the available information. How will your cap table look afterwards? How will it affect future investment? If you haven't adequately considered the deal in all its minutia, you shouldn't be accepting it.
Fixing a Problematic Cap Table
Whether initial investors received too many shares or most of the founders have left the company—or any number of reasons that might lead to a broken cap table—all effort should be made to fix it before the next round of financing.
The first—and most obvious—issue your cap table might run into is incorrect information, be it through lack of update or even mistakes when entering information. Fixing this kind of problem can be laborious, but should be considered a high priority before any future financing rounds.
If it is not already, make you cap table easily accessible to all who need it. In the current era of cloud service, there is a multitude of ways to make this happen, and sharing the burden can make repairing that cap table considerably less painful.
On a related note, if you are working from a standard spreadsheet, consider switching to dedicated software. This will help you more accurately keep your cap table up to date and accurate, not to mention reducing the workload involved with updating it.
You can also mitigate the problem of dilution in future financing rounds with vesting options. In this case, an investor receives a significant stake in the company but is under obligation to reduce their share once specific key performance indicators are reached.
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2020 John Bullock