- Alex Wittenberg
- Joseph Ruscio
What is a Cap Table?
A capitalization table — or “cap table” — is a spreadsheet or table that provides an in-depth view of a company’s equity (including stock, convertible notes, warrants, and grants of employee equity via employee equity plans), that clearly states which stakeholders own what. Cap tables act as a single source of truth that help private companies and their investors understand their capital structure.
Managing cap tables is a critical activity to set up from a startup’s early stages, yet first-time entrepreneurs often overlook this crucial step. And as startups mature, cap tables also record additional important details for your next rounds up through IPO, future rights to purchase additional equity, option vesting schedules, voting percentages, and additional equity management information.
In this post, we asked Alex Wittenberg, Director of Financial Advisory at airCFO, which operates as an embedded Finance, Accounting & Tax partner to hundreds of high-growth startups, to help our community of early-stage founders better understand:
- Why cap table management is important
- Cap table planning (including when companies should begin managing their cap tables)
- A good operating cadence for various cap table management tasks
- Some helpful tips for improving your cap table management
What is Cap Table Management and Why Is It Important?
To start, your cap table is a legal document spelling out your startup’s equity structure. Any mistakes within your cap table are mistakes in your organization’s official ownership documentation.
This doesn’t mean that you can’t fix these mistakes — but it does mean that an incorrect cap table can cause significant issues when seeking investment or hiring employees. And in the past, as startups matured, they would also require additional support for equity management processes, such as hiring law firms to ensure employee option grants are compliant with IRS and SEC regulations.
What Software Tools Can Manage Cap Tables?
Fortunately, modern cap table management is very automatable. While a simple spreadsheet may seem like an easy place to start, there are mature software tools on the market that are purpose-built to support your startup’s valuation journey.
Software platforms like Carta, Pulley and a handful of other tools do much of the work for you, including managing important considerations such as ESOP grant valuations.
What’s Included in a Cap Table?
A standard cap table usually includes:
- Total company valuation - Including total equity value and per-share prices
- Pre-money valuation - Valuation of your company prior to a fundraising round
- New equity raised (for each funding round) - The amount raised for a specific round
- Post-money valuation - Valuation of your company post-raise
- Number of shares - A running log of how many shares are outstanding for your company, specifically recorded by type and by shareholder
- Shareholders - A list of all shareholders, including founders, as well as an individual breakdown of how much total capital each shareholder owns, the type of equity each shareholder owns, total shares held by each shareholder, and percentage ownership of the company for each shareholder
- Employee stock options - Over time, as you hire a larger team and potentially award stock option grants, your cap table should also include the total number of options in your employee pool as part of any employee stock option plans (ESOP)
Example Cap Table
So, what is an example of a cap table I can look at, including all of the above components, you might ask. Here’s an extremely basic example:
In this example, our startup has raised a seed round of $3.5M at $5 per share. Walking through the numbers:
- Pre-Money Valuation - Began at $1.5M prior to raising the seed round, with an initial pool of 300,000 shares.
- New Equity Raised - Our startup raises $3.5M at $5 per share, issuing 700,000 new shares.
- Post-Money Valuation - After the infusion of seed funding, our total valuation hits $5M across a total of 1M shares.
- Founder shares - As noted above, our two co-founders each hold 150,000 shares of common stock, resulting in a post-dilution ownership of 15% apiece. While our two-person startup began with full ownership of all the startup’s shares, after
- Investor shares - Our startup’s investors include a leading investor that takes 400,000 shares of preferred stock, and a secondary investor who takes 300,000 shares of preferred stock, for a total of 700,000 shares (preferred stock, of course, conveying liquidation preference that will pay proceeds to preferred stockholders before common stockholders in the event of an acquisition or winding down of the company)
- Authorized shares - The company has authorized a total of 1.2M shares to allow for additional shares to be added to the company’s ESOP. With its new seed funding, our startup can afford to bring on new hires, and may need to incentivize hiring by offering equity as part of the compensation package.
Cap Table Planning: What First-Time Founders Need to Know
When planning your first cap table, it’s a good idea to be aware of these considerations:
- Simple start, increasing complexity - In the beginning, cap tables are relatively basic spreadsheets that track different classes of stock and options, valuations, and who owns what. Over time, they become larger, more-complicated documents with (hopefully) additional venture capital funding rounds for which you may need a dedicated cap tool management platform.
- Cap tables can drive consensus (or misalignment) - Worst-case scenario: An inaccurate cap table leads to disputes around accounting, equity option grants and stock grants your finance team needs to track for ASC 718 reporting, and internal or outward-facing messaging. Best-case scenario: An accurate, regularly-updated cap table keeps your leadership team on the same page and ensures you can communicate with your employees, investors (and the media, if need be) in a timely manner.
- How to share with investors and employees - Investors will commonly request summary-level cap tables as a part of adding your startup to their portfolio, a fairly standard practice that hopefully shouldn’t be an issue for your team. Employees may request some level of detail, or be largely uninterested. The level of transparency you decide to provide your team will depend on your comfort level (and the comfort levels of your legal and finance teams).
When Should Companies Formally Start Managing Their Cap Tables?
Companies should ensure that they have an accurate cap table on-hand from the very beginning. You can often get by in the early days — when you don’t have outside investors — using an Excel spreadsheet. Once you begin your first funding round, however, you should onboard your company onto a cap table management software platform as soon as possible.
Spreadsheets quickly become unwieldy when you have to track your ownership interests alongside investor stakes and employee stock options. As mentioned earlier, dedicated software providers can handle much of the manual work for you, making it easy to issue shares to your new investors.
While your cap table will eventually become the domain of the genius CFO you’ll be hiring in the future, it’s common for first-time founders to manage their own cap tables with their finance partners, taking advantage of any software-based workflows to save time and manual effort.
Managing Your Startup Cap Table
Let’s look at what a best-practice cap table management cadence looks like for a venture-backed startup:
Each Funding Round
As you gear up to raise a round of equity financing, you should be sure to have a deep understanding of your current capital structure. You’ll also want to be able to model out the impact of a potential funding round on your capital structure to understand how each stakeholder’s ownership percentage will shift after completing the fundraise.
Here some of the top cap table action items for each new round:
- Upload relevant documentation to your cap table platform - Including term sheets, investor suitability questionnaires, investors’ rights agreements, and any amended statements of re-incorporation
- Update your cap table - To reflect the new ownership interests, new valuation, and new share issues
- Sign and distribute ownership interest - Ensure your investors receive final preferred stock investment agreements.
A 409a valuation is a third-party appraisal of the fair market value on a single employee stock option. This valuation determines the strike price – the price at which employees have the right to buy shares of your company’s stock through your Employee Stock Option Plan (ESOP).
Each valuation is valid for 12 months. During these 12 months, you qualify for what is known as IRS “safe harbor.” This means you can rest easy issuing tax-privileged stock options to employees with an expert’s blessing that the strike price is justifiable.
You need to refresh your 409a valuation every year or when your company experiences a “material event” that would affect your valuation (e.g., a funding round) to ensure you stay within safe harbor.
You can do this yourself inside of your cap table management platform, or you can hire a third-party valuation firm to handle it.
Here some of the top cap table action items for 409a valuation:
- Prepare relevant financial documentation - Typically, you’ll need to provide historical financial statements, your current cap table, as well as potentially any relevant board decks with important company updates
- Update your cap table within your platform - As your company matures and your valuation becomes more complex, you may want to consider hiring a third-party valuation form. Proper 409a valuation is vital to making sure your startup is audit-ready and can weather any accounting issues.
As your company matures, you’ll hire employees and grant them options out of your ESOP in the process. Consequently, it’s essential to check on the remaining size of your option pool quarterly so you know when you need to carve out more shares for future employees.
Here some of the top cap table action items for ESOP activities:
- Review stock option issuances - For new hires or employee retention “top-ups” with your board for approval
- Load grants and distribute - Record the new grants in your cap table management software and send off the options to their recipients
- Periodically review your option pool - As mentioned above, a quarterly review of your option pool is a good idea to ensure you’re able to distribute new grants to new team members
Upon Employee Termination
Employees don’t get access to all their options granted from the ESOP right away. Awarded options vest over time, meaning they are unlocked as an employee becomes more tenured with your startup.
A typical vesting schedule is four years with a 12-month cliff. That means the employee doesn’t earn any options until their 12th month at your company — at which point they receive 25% of their total grant. Then, they receive 1/48 (for 48 months) of their options each month for the remainder of this four-year period.
Once an employee’s shares vest, they are free to exercise them at their discretion. However, most employees wait as long as possible to exercise their options so they can be sure that the company’s stock is worth more than the strike price of those options.
Once they leave your firm (voluntarily or otherwise), however, they have 90 days to exercise their stock options, or they forfeit them. For this reason, most employees wait until leaving to exercise their options, and the deadline to exercise is set on their termination date.
Here some of the top cap table action items for employee offboarding:
- Record post-departure exercises - Since employees tend to exercise after they move on, it’s important to update employee information and option pool details in your cap table whenever you have departures
- Record other option changes post-offboarding - In some cases, departing employees may choose to let options expire, so it’s a good idea to schedule a cap table update around the expiration window for any offboarded employee’s options
Additional Considerations: Dilution, Down Rounds, Liquidation
What Is Dilution, and How Does It Affect My Cap Table?
A necessary part of startup funding is the aforementioned dilution, the gradual loss of total ownership as startups take on more financing rounds. Part of the process is your startup bringing in more investors who take partial ownership of your company via their shares.
Another part of the process is you and your co-founders eventually go from initially being 100% owners to being significantly less than 100% owners. As other investors assume an increasing portion of ownership in aggregate, expect to see dilution continue, especially if your startup issues larger and larger distributions of stock each time (which may be common if your startup also raises larger and larger rounds).
Dilution is a natural part of a startup’s lifecycle and is something you can track in your cap table by recording the share ownership of the founders along with the ownership of additional investors and other shareholders.
What Are Down Rounds, and How Do They Affect My Cap Table?
In a perfect world, your startup will raise successively larger rounds of funding over its lifetime. However, there may be challenging markets, especially for companies that recently took a relatively large round previously and have massively diluted shares constituting a huge valuation that may be difficult to maintain.
During tough market conditions when companies have both significantly diluted shares, but need to raise funds to continue their runway, they may be faced with the prospect of having to accept a down round. A down round is a subsequent round of funding at a smaller amount than the company’s previous round. While down rounds certainly aren’t glamorous they may be necessary for a company’s survival.
You’d record down rounds in your cap table as you would other rounds, including total funding amount, and any shares issued to any new investors. Some investors may have anti-dilution provisions in place as part of their preferred stock investment agreements, which means your company may have to issue a numerically higher number of shares to those preferred stockholders. Unfortunately, holders of common stock will tend to see an even larger amount of dilution of their ownership as a result of the math. As your company issues even more shares to other parties, holders of common stock see their percentage ownership shrink that much more.
What Role Does a Cap Table Play During Liquidation?
Cap tables track the aggregate ownership of private companies across various shareholders. In the case of liquidation, in which owners decide to wind down a company and sell off its assets, the cap table’s importance as a reference for who owns what becomes starkly clear.
While liquidation isn’t exactly a thrilling scenario, it does happen and it can be helpful to have some understanding of how to handle the process. In such cases, another item that can be useful to record in a cap table is the aforementioned liquidation preference.
Liquidation preference is a common provision for preferred stockholders that ensures those stockholders get paid out first, prior to any common stockholders, who receive whatever may be left afterwards.
Helpful Tips For Sound Cap Table Management
Set Equity Grant Sizing Rules Up Front
Put an equity compensation plan in place early on so you have numbers to go back to when hiring new employees. Doing so makes it easy to have those conversations when you bring employees on.
For example, you might define that manager positions get 0.25% equity, director-level employees get 0.5%, and C-suite executives get 1-5%. You can refine these rules further by segmenting your equity allocations by department. This Venture Hacks post gives a rough set of benchmarks for a Series A-stage startup, which you can tailor to your specific stage/situation.
Consider Your Hiring Plan When Sizing Your Options Pool
As mentioned earlier, monitoring your options pool on a quarterly basis helps prevent you from overdrawing and causing issues. Taking this a step further, frequently reviewing your 12-month hiring plan can help you keep your options pool at an appropriate size.
For example, your hiring plan may include hiring 2 new C-suite executives and 10 entry-level employees within the next year. Perhaps your grant sizing plan gives that C-suite executive, say, 1% equity in the company. Meanwhile, the entry-level employees might each get 0.2% equity. Additionally, you can expect that you’ll be topping up equity grants for several employees, which will require you to earmark an additional 2% worth of shares. Knowing all this, you can do some quick math to calculate that your options pool will need to consist of 6% of your total shares outstanding for the next 12 months.
Your Cap Table Scales as You Scale
When a company first forms, your cap table will likely only contain the founders’ ownership stakes. But founders have a lot on their plates and as your company scales, it’s easy for cap table management to fall through the cracks. Neglecting your cap table can be disastrous, so don’t be afraid to ask for help or have an expert manage it for you.
AirCFO is a partner of Heavybit’s Perks and Discounts Program, which we offer exclusively to members of our portfolio. If you’re interested in joining the accelerator, you can learn more and apply here. If you’re just looking for more information on understanding and getting your cap table in proper order, check out the resources on airCFO’s site.