Startup Equity 101: Understanding and Managing Your Cap Table

In this blog, we'll provide a high level overview of cap tables, ownership types, dilution, valuations, and the importance of maintaining accurate records. We will break out details on each of these in subsequent posts.

What is a Cap Table?

A capitalization table (cap table) is a document that outlines the ownership structure of a company. It details the various types of equity ownership within an organization, including common and preferred shares, convertible instruments, and options. A cap table provides a snapshot of who owns what within a company.

When should you start it?

Founders should create a cap table when they form their company, issue equity to co-founders, or raise funds from investors.

How do you set it up?

1. Creating: A cap table is usually created using a spreadsheet or specialized software. It should include details about each shareholder's equity ownership, the type of shares held (common vs preferred), date that the shares were acquired, cost per share acquiredinvestment round. . The cap table should also reflect all options issued. The options can be recorded as a single line item with a separate spreadsheet acting as the options register listing the details of each option issuance.
2. Organizing: The cap table should be organized to provide a clear view of each shareholder's ownership, including the type of equity they hold (common shares, preferred shares, options, etc.).
3. Managing: A cap table must be kept up-to-date, with all equity transactions recorded and adjustments made for any changes in the company's ownership structure. Founders can do this on their own but typically work with a law firm to maintain the cap table.

Ownership Types

Equity

• Common shares: The basic form of ownership in a company. Common shares are normally what founder receive. Common shares typicallyprovide voting rights.
• Preferred shares: These shares normally have priority over common shares in terms of dividend payments and liquidation proceeds. Preferred shares may also be converted to common shares at some pre-determine ratio.
• Liquidity and bankruptcy: In the event of a company's liquidation or bankruptcy, preferred shareholders are paid before common shareholders.

Rights

• Convertible instruments: Securities that can be converted into equity at a future date, often upon the occurrence of specific events.
  • Convertible Notes: Debt instruments that can be converted into equity at a predetermined conversion rate. They normally come with a discount rate, triggers (maturity date, next raise), a valuation cap, and potential challenges and risks.
  • SAFEs (Simple Agreement for Future Equity): A contract that provides the right to purchase equity at a future date, usually upon a specific trigger event. SAFEs come with favored nation status and potential downsides or risks.
• Options: The right to purchase shares at a predetermined price, typically granted to employees as a form of compensation. Options involve vesting schedules (time-based, milestone-based), cliffs, post-termination exercise periods (PTAP), and expiration periods.

Dilution

As new shares are issued or equity is granted, existing shareholders' ownership percentages decrease, a process known as dilution.

Valuations and Strike Price, FMV (Fair Market Value)

• 409A valuation: A valuation used to determine the fair market value of a company's shares. It involves different approaches, such as the market, income, and asset approaches, and typically costs between $1,000 and $10,000.
• Rule 701 disclosure: A regulatory requirement for private companies issuing equity compensation that provides information on the company's financial health and potential risks.

Getting Started

It's never too soon to formalize your cap table. In addition to the investor, employee and control benefits mentioned above, it will be much easier to create and maintain if you start before it gets too complicated.