As an entrepreneur or business owner, you’ve undoubtedly run into the term “cap table” before. In its most basic form, a cap table is a spreadsheet or table that shows the equity capitalization for your business.
You most often find cap tables when dealing with startups and early-stage companies. It’s one of those “must-do” tasks that every business owner faces — and it is certainly an intimidating one. Follow the guide below and you’ll be able to design and produce a well-crafted cap table for your startup.
What Actually is a Cap Table?
When a startup or early-stage company is establishing itself, questions of ownership are of the utmost importance. A cap table is what young companies use to clearly showcase the company’s capital structure.
A cap table lists the company’s securities. Think of this as a catch-all phrase that covers many different financial instruments including:
- Stock issuances
- Stock options
- Vesting structure
In practical terms, a cap table breaks down the “who owns what” of your business. With a cap table, you can see the different types of equity ownership, the names of each equity holder, and other relevant information that pertains to ownership in the company.
Or, in other words, your cap table tracks the ownership percentages of your company.
It’s Just a Table?
Pretty much, but a cap table can take different formats (e.g., table, spreadsheet, and so on).
Cap tables for companies later in the startup phase might include far more information than you might initially imagine. For example, an advanced cap table may include information on mergers/acquisitions, employee stock options, restricted stock transfers, and much more.
Why is a Cap Table Important?
The most obvious and immediate reason to have an up-to-date cap table is that it’s really important to know who owns what!
That information is vital to your business. A cap table shows current investors the equity structure of your business — important information to have in the event of a payout, acquisition, or dilution.
Future investors need to see a current cap table in order to make an informed investment decision about your business. Likewise, a cap table allows current employees and equity holders to view the current value of their stakes.
What About Selling My Company?
If you decide to set off for greener pastures—sell your company, in other words—a cap table is one of the most important documents the other party needs. The purchaser will vet every aspect of your cap table down the last exacting detail.
Stock options, sales, acquisitions, shareholder agreements: you can’t afford to ignore one iota of information.
What About Regulatory and Tax Compliance?
This is another area where having an updated and comprehensive cap table is a lifesaver. Equity-based compensation is a complicated area of IRS tax regulations that is not the place to experiment.
Remember, cap tables act as an important summary of the information found in your business’s legal documents. In the event of an audit, the IRS will need to see your cap table.
Where Do I Start?
Getting your capitalization table off the ground takes a bit of doing. Unfortunately, it’s an important process that often gets bundled up in other important startup discussions.
Step 1: Agreements, Records, and Word-of-Mouth
Many businesses find their origins in casual conversation between friends, family, or coworkers. Imagine two friends—Mary and James—decide to start a company together. They might both decide, informally, that each will contribute $10,000 to get the company off the ground.
This is a basic 50:50 split. Both Mary and James agree that each of them will receive 50% ownership and call it a day.
That’s a great start — but things are rarely so easy.
In some cases, Mary and James may contribute different amounts of their personal money to fund this hypothetical company. Their cap table needs to account for that variance — perhaps Mary’s $15,000 receives 50% more equity than James’ $5,000.
Regardless of the details, there is a chance that this conversation may be quite awkward. It’s one thing to talk about a business or plan it on your own time, but a cap table helps put things in perspective.
- Take the time to sit down with your co-founders and figure out exactly what sort of initial agreement you want to use moving forward.
- Have an honest and frank discussion on the use of personal money for investment.
Note: These early-stage agreements are preliminary in nature. They needn’t be complex — but write them down.
Step 2: Making Your Cap Table
Once your initial agreement is in place, you’re free to dive straight into the world of company formation. For the purposes of this guide, we’ll skip discussing the incorporation process (consult with a professional accounting firm for advice on this if you feel lost).
Once you’re incorporated, it’s time to nail down your first serious capitalization table. You want to take care of this after incorporation but before you start bringing on employees or additional investors.
At this point, your business is just you and your co-founders. Barring some very unusual circumstances, your equity distribution can probably fit on the back of a napkin. Going back to our example of Mary and James — each partner owns a 50% in their company and that’s it.
In terms of what information to include, you’ll want to make sure your cap table covers the following topics:
- Number or amount of total shares issued by the company
- Number or amount of shares issued to each founder
- Number or amount of stock available in the employee stock option pool
- Date of issuance
- Stockholder name
- Vesting schedule
- Company formation date
Note: Formatting is up to you, but keep it simple and consistent. Stick with a basic spreadsheet (names of investors on the Y-axis, securities on the X-axis)
A Few Tips
Your cap table is a living document. It’ll go through changes as your company grows and expands. Use a professional suite of software like Microsoft Excel to keep it in an easily accessible format. As mentioned above, be consistent: use full, legal names, avoid abbreviations, and take the time to write things out.
Make it a point to have copies of all relevant legal documents on hand. For example, copies of approved stock agreements, options, and vesting schedules are invaluable when crafting your first cap table. Remember, a cap table summarizes existing formal agreements — it doesn’t replace them.
Step 3: Complicating Your Cap Table
So, you’ve got your initial cap table. If you’re like most startups, you’re only dealing with yourself and a handful of co-founders.
However, it’s probably time to start bringing on additional employees and outside professionals. Stock compensation and stock options are some of the most attractive offers a startup can make to a prospective hire.
You have the option of offering stock compensation as either a percentage of company or an absolute number of shares. As a general rule, startups should offer an absolute number of shares in lieu of percentages — it’s more accurate and easier to manage.
Note: If there’s one area that makes cap tables a nightmare, it’s here. Issuing stock options to employees gets complicated really fast.
Every stock grant, every vested share, every stock option — record it all. Your business needs to keep an accurate, updated record of every aspect of your equity structure. That includes tracking stock repurchases, stock transfers, restricted stock, and plenty more.
What About the Employee Stock Option Pool?
Most startups offer employees “restricted stock” (stock subjected to an agreed-upon vesting schedule). Startups grant restricted stock to employees on the condition that they stay with the company for as long as the vesting schedule dictates.
If an employee leaves the company before their shares have vested, they lose their shares.
Note: It’s standard practice for companies to perform a 409A valuation once the company is able to offer common stock options.
Step 4: Dealing with Investors (Pre-Series A)
At this point, your startup is likely looking for seed capital. This is where investors (outside investors, that is) come into play.
Outside investors take many forms: angel investors, venture capital firms, and so on. Every outside investor needs to see your cap table — they need to examine the equity structure of the company they may invest in.
As a general rule, keep your cap table current, clear, and easy-to-read. Investors don’t want to waste time trawling through an unnecessarily complicated document.
Step 5: Hooray for Series A
Your first equity round—Series A—is the make or break of most startups. Your cap table plays a vital role in this step.
A single mistake on your cap table, no matter how small or seemingly irrelevant, is potentially damaging when dealing with Series A funding. After all, potential investors are looking to go into business with you — a mistake on something as important as your cap table is unforgivable.
On top of this, a cap table is what a potential investor will look at when determining how much of your company they seek to own. You need to know exactly how much equity each stakeholder owns (and how much you’re willing to part ways with). Your potential investor may also require changes to the employee stock option pool, significantly changing the equity structure of your business.
Common Cap Table Mistakes
Most problems with cap tables result from a lack of experience, a lack of technical accounting knowledge, and an inability to track changes. If you’re set on handling your cap table by yourself, make sure you do your due diligence. As mentioned above, there is a lot riding on a well-crafted cap table.
Common Mistake #1: Not Tracking Changes and Transactions
This most often occurs when an employee with stock options leaves the company. When an employee and startup part ways, it’s critical that the business follows through on terminating exercise windows. More often than not, businesses do not update their cap tables and wind up granting stock options to non-qualified former employees.
Track and record every change to your company’s equity structure. That efforts pays off.
Common Mistake #2: Being Inconsistent
Inconsistency is a recurring mistake on many capitalization tables. Dates must agree and names must match. As a general rule, stick with official titles, full legal names, and avoid abbreviations whenever possible.
Imagine a potential investor looks through your cap table and sees two or three different versions of a stakeholder’s name! It’s both unprofessional and confusing.
Common Mistake #3: Slow or Irregular Updates
An outdated cap table is of little use to anyone. Slow or irregular updates often result in:
- Incorrect or missing shareholders
- Erroneous share allocations
- Mistaken contact information
It’s critical that your business keeps your cap table updated with current information.
Common Mistake #4: Incorrect Cap Tables Flying Around
The startup phase for a company is a hectic time. Different versions of cap tables may fly around the workplace with wild abandon. Make absolutely sure that everyone is on the same page when it comes to your cap table — no mistakes!
Common Mistake #5: Doing it Yourself
A capitalization table is a fundamental document for any startup or early-stage business. Inexperienced hands may very well produce an accurate cap table, but the risks are readily apparent. An incorrectly-prepared cap table may open the company up to serious questions regarding equity distribution, capital structure, and investor rights.
Capitalization Tables with Founder’s CPA: Startup Accounting Professionals
Creating your own cap table is doable, but you might need a guiding hand now and then. After all, this is a crucial document that will follow your business from beginning to end. If you need help working on your cap table, reach out to Founder’s CPA Group for professional accounting expertise.