Cap tables for startup founders
LTSE Equity
The prospect of building a startup and taking it from pre-seed to its initial public offering (IPO) is a venture that’s as exciting as it is daunting. As startups grow in size, they also grow in complexity and can overwhelm even seasoned founders.
A well-maintained cap table can be the guiding north star for founders. By tracking key information such as ownership structure and equity transactions, cap tables help founders stay on top of their startups’ evolving needs and serve as a reliable reference point for all stakeholders.
To understand what cap tables are, why they’re so essential, and how to maintain them, amongst other things, read on.
What are cap tables?
A cap table (also known as a capitalization table) is a spreadsheet or table that records the equity ownership structure of a startup. It provides a comprehensive overview of a startup’s securities (e.g., common stock, warrants) and detailed information on stakeholders, and their level of investment and ownership. In short, a cap table paints a picture of a startup’s financial and equity capitalization status.
Ultimately, cap tables are tools used by founders and investors when making key business decisions as they:
- Help founders closely monitor their startup’s ownership and equity distribution which enables informed decision-making (e.g., planning for equity compensation packages).
- Help investors by providing a transparent, thorough view of the startup which enables informed investment decisions.
Do startups need cap tables?
Unlike 409A valuations, having and maintaining a cap table isn’t an enforced legal requirement per se. That said, cap tables, when done right, provide startups with a host of benefits that go beyond listing who owns what.
Here’s a breakdown of why startups stand to benefit from cap tables:
Keeps track of ownership
By the time founders secure funding, their startups would be comprised of several types of stakeholders including founders, employees, and various types of investors (e.g., angel investors and venture capital firms). Cap tables make it easy for founders to track relevant ownership changes to minimize confusion and potential disputes.
Supports decision-making processes
Cap tables can act as a point of reference for founders in making strategic, well-planned decisions. It is crucial for startups to comprehend the distribution of their assets and securities to create equity compensation plans, negotiate with investors, and support other business dealings.
Facilitates clear communication
Cap tables provide a visual and straightforward way to communicate a startup’s ownership makeup to readers within and beyond the startup. This helps prevent misunderstandings and promotes transparency among all stakeholders.
Helps with fundraising
Investors love well-maintained cap tables (and excellent financial housekeeping in general) because they cut out the guesswork from the equation. Up-to-date cap tables help potential investors get the information they need to make rapid decisions and signal that the startup is well-organized.
Components of cap tables
While initiatives like the Open Cap Table Coalition are gaining momentum, there isn’t any universally imposed format that cap tables have to adhere to. The makeup and layout of a cap table depend entirely on the unique circumstances of a startup. That said, cap tables generally include the following:
Authorized shares
Authorized shares are the maximum number of shares a startup is permitted to issue as stipulated in either its bylaws or articles of incorporation. For instance, the total number of shares a startup is allowed to give away as part of either fundraising efforts or equity compensation.
Issued and outstanding shares
Issued and outstanding shares refer to the total number of shares that have been given by a company to its shareholders. Outstanding shares are those which have been distributed internally (i.e., to investors or founders) whereas issued shares are shares that have been made available to the public (e.g., common stock).
Reserved shares
Reserved shares are shares that have been specifically set aside (usually from authorized shares) for future use, such as for granting equity to employees. These also come with restrictions like vesting schedules that aren’t readily available for transfer or sale.
Shareholder information
Perhaps one of the most important components, shareholder information lists the names of all shareholders along with their addresses, the quantity and types of shares owned, and their percentage of startup ownership.
Option pools
Option pools are a portion of the startup’s authorized shares that have been specifically allocated for employee equity compensation purposes. These are highly important as equity compensation can help attract and retain talent.
Convertible notes
Convertible notes are a form of short-term debt that can be converted into a pre-specified and agreed-upon amount of equity once certain conditions are fulfilled (e.g., securing fundraising).
Example of a cap table
Creating and maintaining a cap table is only one side of the coin. The other requires founders to know how to read them inside out. While we’ve covered some of the most important elements cap tables contain, let’s take a quick look at a cap table sample:
The table above is a high-level overview of a hypothetical startup’s cap table in its Series A stage. Starting from the top of the y-axis, the table lists the startup’s common stock, followed by preferred stock, stock plans, warrant plans, convertible securities (e.g., preferred stock), and ending with the total.
Conversely, on the x-axis, starting from the leftmost column, we have authorized shares, issued and outstanding shares, fully diluted shares, ownership by percentage, and capital contribution (i.e., the amount each shareholder invested in the startup).
The table gives a summary of the startup’s ownership structure and it’s important to note that the way the information is organized and presented will vary between startups.
Best cap table practices to remember
Creating and managing a cap table can be overwhelming because of its complexity and the potential for costly errors. Nevertheless, founders can keep headaches to a minimum by following these tips:
#1 Frequently update your cap table
For a cap table to be a single source of truth (SSOT), it has to accurately reflect the most up-to-date information. Without regular updating, cap tables would be obsolete—nothing more than a historical record.
Staying on top of this requires founders (or whoever is delegated to the task) to be diligent; habitually updating the table whenever an event that impacts your startup’s equity ownership structure occurs. Examples of such events include:
- Bringing onboard new shareholders
- Issuing new shares from existing securities
- Transfering shares between shareholders
- Going through a new round of funding
#2 Seek professional advice
The chief cause of poorly-maintained cap tables is often the founder’s lack of experience and investors’ overestimation of the founder’s skills. It wouldn’t be a stretch to say that good cap table maintenance is a skill that requires years of practice, which founders often lack especially during their startup’s early stages.
Founders should seek professional advice when possible. Experienced lawyers, accountants, and financial advisors bring a wealth of experience to the table and can provide a fresh perspective to stay on track. They can also offer valuable equity and non-equity-related advice. Questions founders could ask advisors include:
- How can we minimize inaccuracies and mistakes in our cap tables?
- What are the implications of fundraising rounds on our cap table?
- How will the valuation of our startup impact our cap table?
- Can you update us on the implications for our cap table if there are any changes in the regulatory environment?
#3 Keep things simple
As startups evolve, the number of stakeholders as well as executed transactions increases. Because of this, it’s common for cap tables to become convoluted and complicated, making understanding them a painstaking task. This can also increase the risk of errors and make decision-making a challenge.
Founders must trim through the fat to keep their cap tables clean, simple, and concise. To achieve this, startups should:
- Implement a clear, standardized cap table documentation process.
- Delegate the task of maintaining the cap table to free up founders’ capacity.
- Consider using dedicated cap table software (e.g., LTSE Equity).
Consequences of a poorly maintained cap table
Poorly maintained cap tables spell far-reaching consequences for startups. They can impact startups internally by causing internal disputes; and externally, by impairing a startup’s fundraising efforts. Other consequences include:
Internal disputes
Unkempt cap tables are not just difficult to read. They can cause confusion over equity distribution and your startup’s ownership structure. For instance, shareholders may wrongly assume that they own more than in actuality, ownership may be unknowingly diluted, and equity could be misallocated. These issues can easily lead to arguments and legal disputes that can derail your startup’s entire operations and have been the downfall of many budding startups.
Fundraising difficulties
Even beyond a startup’s walls, the consequences of a poor cap table will continue to negatively impact your startup when securing investors for two reasons. First, investors will not be able to readily understand your startup’s ownership structure, causing them to be wary due to the lack of clarity. And second, disorganization sends a poor impression to investors, who might believe that your startup doesn’t take its finances or operations seriously.
Tax issues
Cap tables are more than just records of ownership. They are used for tax purposes and play a crucial role in ensuring your startup remains on the right side of the law So, poorly-maintained and inaccurate cap tables can lead to the inaccurate calculation of tax payments (e.g., tax implications for equity compensation plans) and can cause startups to either over or underpay their taxes.
Different types of cap tables
We previously mentioned that there is no universally imposed format when creating cap tables, as each cap table depends on your startup’s situation. As a result, cap tables can vary greatly in format and content. However, there are a number of different types of cap tables that serve a distinct purpose, including:
I. Basic cap tables
Basic cap tables (also called simple cap tables) are the bread and butter of many startups. They’re the simplest type of cap table and are often used by very early-stage startups before things get complicated.
It usually includes the bare minimum to present a snapshot of the startup’s ownership. Components include authorized shares, shareholder information, issued shares, and outstanding shares. However, elements that account for any future share issuances (e.g., via options) are often omitted.
II. Fully diluted cap tables
Fully diluted cap tables depict share ownerships at any given time and also account for additional shares that could be created in the future through options, warrants, and other related securities. In other words, it assumes that all possible dilutive events have already occurred.
Unlike basic cap tables, fully diluted cap tables go the extra mile and create a more holistic picture of startups, focusing not just on the present ownership structure but the potential future structure as well. This can be used to make forward-looking decisions by both investors and founders alike.
III. Pro-forma cap tables
Pro-forma cap tables are projections that illustrate what the startup’s ownership structure would become if the startup went through certain events, such as financing rounds, buyouts, buybacks, or being involved in mergers and acquisitions. They show what happens to a startup’s capital structure presently and after potential investments.
Tables like this are appealing as they enable founders and investors to understand the future impact of equity transactions on the startup’s ownership structure (and by extension, ownership rights).
3 types of cap tables, summarized
Basic Cap Tables -> Provide the most straightforward representation of a startup’s equity ownership structure.
Fully Diluted Cap Tables -> Factor in the issuance of any type of future equity that could impact the startup ownership structure.
Pro-Forma Cap Tables -> Present a projection of a startup’s future equity ownership structure in light of potential investments.
How cap tables preserve a startup’s mission
Cap tables play a critical role in ensuring that a startup stays on track toward fulfilling its mission, both within and beyond the startup. While cap tables are on one level, simply spreadsheets filled with numbers, on another, they see to it that startups stay true to their mission:
Internally
Transparency
Cap tables make certain that everyone in the startup is on the same page. They promote transparency by providing a clear and accessible record of the startup’s ownership structure, fostering trust and stability among stakeholders, and minimizing potential internal disputes.
Interest alignment
Because cap tables document the equity structure of a startup, they ensure all shareholders understand their stake and the impact of business decisions on their equity position. This promotes collaboration and ensures that everyone works together toward the success of the startup as its success is tied to theirs.
Externally
Hiring
Cap tables can help illustrate how a startup has set equity aside specifically for diverse hiring which can demonstrate its dedication to promoting inclusiveness and diversity. A commitment to a mission like this can attract top talent and even investors who share the same values.
Compliance
By clearly documenting the ownership structure of a startup along with tracking vesting schedules and equity grants, cap tables support compliance efforts as they provide the documentation required by many regulatory bodies and can be proactively used to minimize legal risks (e.g., securities violations) that could sidetrack a startup from its mission.
The best way to make a cap table
While it is true that there is no single way to create a cap table for your startup, this doesn’t mean that there isn’t an optimal way. Founders have three options at their disposal: adapting existing templates, using software like Excel, or using a dedicated cap table solution like LTSE Equity.
Using templates
Templates are tempting due to their vast availability online and the fact that they’re often free to download and use. Likewise, as cap tables are generally similar for the majority of startups, tweaking them to fit your needs is a straightforward experience:
Using Excel
Almost everyone is familiar with Excel. It’s a versatile tool and the method of choice for many startups thanks to its affordability and functionality when compared to templates:
Using dedicated solutions
Dedicated cap table solutions (e.g., LTSE Equity), on the other hand, provide a streamlined approach for startups making it the most efficient and stress-free approach:
Why LTSE Equity
If you’re a founder looking for a solution for your startup, why not consider LTSE Equity? Our solution provides one of the most intuitive, easy-to-use, and secure cap table management experiences in the market.
Having served thousands of startups across countless industries from seed to series A, B, C, and beyond for nearly a decade, it isn’t an exaggeration to claim that our customer support and startup-friendly pricing is one of the, if not most, competitive in the marketplace.
To get a feel of what we can offer your startup, we invite you to give our extensive public demo a whirl!
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