As a business owner, great prosperity could emerge over time. Through its growth, you’ll likely raise capital from investors by selling shares of stock. Your company and ownership percentage will change, which begs the question: “Where do I keep track of my ownership percentage?”
In the capitalization table, or “Cap Table,” as the kids say! The Cap Table may seem like a tedious inventory of outstanding shares of company stock, but I am here to tell you something very important.
Your Cap Table is your everything!
Let’s break this down Letterman-style with the Top 10 Reasons Why Your Cap Table Matters.
And that somewhere should not be on a whiteboard or notepad! Start in Excel and keep a clearly labeled file name with the date, something like “OFFICIAL CAP TABLE – 9.21.2024,” so it unequivocally represents the ownership at a given period of time.
Password-protect the file in a folder with limited access and keep it in your document management system. Keep a subfolder of archived or out-of-date versions; you never know when someone may want to see the ownership at a particular date.
Within the spreadsheet, start by identifying the number of authorized shares your company has. You’ll find the share count in your charter or certificate of incorporation, which you filed when you incorporated (likely as a Delaware corporation). The authorized shares represent the number of shares the corporation is legally authorized to issue. Have plenty of authorized shares; otherwise, you must amend your charter, which may require board and investor approval.
You can issue shares once you’ve identified the number of authorized shares. At this point, you’ll likely give shares of common stock to the founders. Be sure to list the name of the stockholders, the number and type of shares they own, and the percentage of the outstanding shares they own.
With your Cap Table started, you’ll want to ensure it articulates each founder’s stock percentage. There’s no more important relationship in a business than the one between co-founders. The worst mistake you could make is not being in explicit agreement about each co-founder’s ownership stake. There’s no better way to remove that uncertainty than to have those ownership percentages in your Cap Table!
The founders’ shares also represent the starting point. With shares issued to founders, you can start building the rest of your team and investor community.
If you plan on hiring employees, you must issue stock options. We covered stock options in our previous post, but what is important here is that you include your stock option pool in your Cap Table to (i) keep track of all stock option issuances and (ii) build a clear understanding of every shareholder’s fully diluted ownership percentage.
A fully diluted ownership percentage represents what a stockholder’s ownership percentage would be if all stock options, warrants, and other convertible securities (i.e., a convertible note) were exercised and shares of the stock were issued. This fully diluted ownership percentage is essential because existing and prospective stockholders will want to understand exactly how the stock option pool and all outstanding convertible securities impact their ownership.
The Cap Table is one of the most critical elements of your data room. It is one of those documents that every investor (and every investor’s lawyer) will review carefully, so have it ready immediately.
One way to ensure your Cap Table is continuously updated is to schedule 30 minutes each month to review it, complete any updates, and provide all updates are appropriately documented (more on the importance of documentation below).
Even if you didn’t raise money and sell shares in the past month, you may have issued new stock options, previously issued options may have reached a vesting milestone, or an employee may have left and forfeited options, all of which makes it quite valuable to complete a monthly Cap Table check-in.
As mentioned above, the initial shares you issue will likely be common stock. But as you scale and raise capital from outside parties, you will likely issue preferred shares (Series A, Series B, and so on).
Each class of preferred shares will have different attributes (i.e., the unique rights associated with each stock type). One of the most common attributes is that each subsequent class of stock receives liquidity preference over the previous. For example, in the event of a sale of the company, Series B shares liquidate before Series A shares, which liquidate before common shares. The exact manner in which this liquidation occurs will be outlined in your charter.
Therefore, when constructing your Cap Table, you must list every stockholder and the number of shares each person owns. In addition, you must break down the number of shares each stockholder owns by class of stock (Common, Series A, Series B).Think of it this way in your spreadsheet: your shareholders will fill your rows, and your classes of stock will fill your columns.
With a detailed Cap Table, you’ll get a clear snapshot of how many shares exist in each class and how much you may have diluted yourself by issuing certain types of stock (remember, founders’ stock will likely be common). You can model out certain exits yourself and see what proceeds will remain for the common stockholders. You can also prepare for future financing rounds by creating pro forma Cap Tables on separate tabs to give yourself a sense of what a future funding round may cost in terms of dilution. Dilution, of course, can be offset by dramatic increases in the stock price.
In addition, you will get a clear snapshot of who controls each class. Certain classes of stock may have certain rights (i.e., the power to appoint a board member, approve a sale, or increase the stock option pool), which require a majority vote from that class, and it is helpful to know the investors who constitute such a majority. You can prepare for what may lie ahead regarding approvals you’ll need to seek from your investors.
The Cap Table represents your understanding of the company’s ownership structure. With a well-maintained Cap Table, you can ensure your account matches the reality of what is documented.
Each person’s presence in the Cap Table, whether as a shareholder or option holder, must be backed up by documented evidence of ownership; failure to do so could create serious issues. At best, it is an oversight everyone will fix. At worst, it could lead to an expensive dispute that disrupts the company and its ability to raise money.
Founders should regularly spend time with their Cap Table, but they shouldn’t do it alone.
First, founders should ensure current board members and key investors understand and agree with the Cap Table. No need to share the Cap Table at every board meeting, but it is worth doing at least an annual review with the board and key investors.
Second, an experienced law firm will provide a ton of help here. At its genesis, the Cap Table is a numerical translation of the company’s charter, so your law firm will play a critical role in Cap Table development. That role will become even more important as you build out your stock option pool and maintain a comprehensive set of corporate books to document all ownership (see above!). Do yourself a favor and get the proper legal counsel.
Third, the right software solution will help you automate Cap Table management when the time is right. Some may argue for using software solutions from the beginning (and their argument has merit). Still, I see tremendous value in managing the Cap Table in Excel and modeling various ways the company’s ownership structure could evolve. But, but, but, you don’t want Cap Table management to become a time-consuming activity. Don’t wait too long to onboard the best software solution for your company.
Modeling out various ownership structures could reveal a troubling truth for founders: Even if the company grows, there may not be much left for common stockholders.
This is incredibly true for climate tech founders because climate tech companies can be capital-intensive and subject to long commercialization timelines.
The liquidation priority of preferred shares and the liquidation preferences associated with each class of preferred shares can be a menacing one-two punch for founders. But better to know that by keeping a well-maintained Cap Table, so you can fight back.
First, founders may want to acquire preferred shares. Founders can invest their capital or negotiate purchases with their boards (most likely through loans to purchase shares). All such investments should be made after careful consideration by the founders.
Second, founders can push for more options. It doesn’t solve the priority issue created by preferred shares, but it could help against dilution.
Third, founders need to be particularly mindful of liquidation preference and push back against it so that it doesn’t wipe out founders’ equity in the case of a sale.
Above all else, the Cap Table is a numeric representation of the founders’ financial future. Building a startup requires so much hard work. You want to be sure that hard work pays off with a clear pathway to financial prosperity.
That prosperity can come with salary and benefits, but the most meaningful capital will come through ownership. As you build a powerful product and generate revenue, it is critical to understand your ownership and how the company’s future capital needs will impact it.
Your financial future depends on it!