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A capitalization table — often shortened to “cap table” — shows a breakdown of your startup’s ownership by stakeholder. A cap table makes it easy to see who owns what, and it helps you and investors understand your firm’s capital structure.
Managing this cap table is a critical activity to set up from a startup’s early stages, yet it often gets overlooked by founders.
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:
To start, your cap table is a legal document spelling out your startup’s equity structure. That means that 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.
Fortunately, cap table management is very automatable. Software platforms like Carta, Pulley and a handful of other tools do much of the work for you.
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 handles much of the manual work for you, making it easy to issue shares to your new investors.
Let’s look at what a best-practice cap table management cadence looks like for a venture-backed startup:
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.
When you do close on that round, you’ll need to update your cap table to reflect the new ownership interests. That means logging in to your cap table software to upload all relevant documentation, then signing and sending certificates of ownership interest to your new shareholders.
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.
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.
From there, you will review stock option issuances for new hires or employee retention “top-ups” to the board of directors for approval during board meetings. Once they approve the issuance of those options, you can load the grants into your cap table management software and send them off.
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. Thus, it’s critical to update employee information in your cap table management software every time an employee leaves your startup.
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.
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.
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.