Capitalization Table

What is a Capitalization Table?

A Capitalization Table, or Cap Table, is a record of a company’s shareholders and their holdings from inception to the present. It is essential in private companies as it shows the breakdown of equity capitalization, ownership, and the company’s valuation throughout its life.

Why is a Capitalization Table Important?

A cap table contains the current list of all company shareholders (including founders, key employees, investors, and ESOPs), their holdings (including common stock, preferred shares, options, warrants etc.), and the value assigned to their ownership at the time of investment (and subsequently). Whenever ownership changes, it is imperative that it is detailed in the cap table and kept up to date.

Cap tables are an important and dynamic tool for managing a startup’s equity account and can be for valuation and to understand the potential for dilution from future investments. This is helpful for both current and future financing rounds. As a formal record of a company’s equity, it is used by founders, employees, current and potential new Investors, and tax authorities.

Ownership Dilution

Cap table “dilution” refers to the reduction in existing shareholders’ percentage ownership when new shares are issued. Think of company ownership as one big pie. When the company is established, the founders own all the pie. Each time new shares are issued to new investors, employees, or advisors, they each receive a slice of the pie. The founders must share the pie with others and each time they do that they will see their own piece of the pie become smaller.

The company’s valuation will likely change over time, and this is also recorded in the cap table. Analysts would expect the valuation to be low at inception, and rise according to milestone achievements in sales, client base, and profitability as the company grows. So, the pie is expected to grow, and increase the value of each equity stake, even if the percentage ownership is slowly diluted.

The company valuation is usually agreed at the time of a new funding round or financing event. There may be instances when a company’s valuation is lowered – known as a Down Round. This may be due to economic cycles, internal issues, slow growth, or simply to offer investors an attractive entry point to invest in the company.

The earlier someone joins or invests in the company, the more they will be diluted in percentage terms as each dilutive event occurs. Every time a dilutive event occurs, the founders and all the other shareholders on the cap table at that time will be equally diluted, unless they have special anti-dilution rights.

Why the Capitalization Table is Important

There are several purposes of a Cap Table:

1. Founders, investors and employees must record their ownership percentage and amount invested in the company where applicable.
2. It also specifies potential dilution each time a new round of capital is raised, new shares are issued, or new shares are added to the stock option pool as incentives for employees.
3. It is essential for company owners to evaluate potential decisions around opportunities that may impact the company’s equity structure, such as new investors, a merger or acquisition, or changes to the company’s valuation.
4. Management will need to disclose the ownership and valuation of the company to new potential investors.
5. All shareholders want to understand what their ownership may be worth at exit.
6. It allows founders and investors to ensure compliance with tax and other regulations related to equity stock, options, and warrants.

How to Create a Capitalization Table?

Cap tables come in all sizes and formats, but the basic components should include:

1. The names of all the major shareholders and many shares of each class were purchased (recorded by date) and the number of shares they own as a result.
2. All the classes of stock and the price per share at the time of investment.
3. The total investment cost and total share count.
4. Any changes to ownership since the company’s inception.
5. Current fully diluted ownership, which includes the options, whether issued, non-issued, vested, or non-vested.

How to Update the Capitalization Table after Creating an ESOP

Startup founders will often carve out an Option Pool (or ESOP/Employee Stock Option Pool) as an incentive to offer to key employees.

In the example below, the founders, who currently own 100% of the company, want to add an option pool for key hires equal to 7.5% of the company. The new shares added to provide ownership results in dilution for the existing owners.

As the table shows, by adding a 7.5% employee stock option plan, the ownership of the founders is reduced to 92.5%.

How to Update the Capitalization Table after a Financing Round

Another common dilutive event accompanies financing rounds, in which new investors come into the company and offer capital in exchange for an ownership stake. Any investment or change in ownership will require the cap table to be updated. In the example below, the company received US $1m capital for 10% of the company, which means that all the shareholders in the company, which in this case are the founders and the option pool, will see their ownership stake diluted by 10%.

In certain financing rounds, the VC investors require that the option pool be “refreshed” or “topped off” to avoid dilution. If this were the case in the above example, the dilution associated with the option pool would be taken before the financing round and out of the pre-money valuation to maintain a 7.5% option pool at the closing of the financing round.

Why the Capitalization Table is Important

Access the Capitalization Table Model in the free download section.

In this cap table example, we can see that when the company was started, it had two co-founders who each received 925,000 shares, although the company did not yet have a firm valuation. Its first funding round raised US$1m of capital and saw 400,000 shares (between 4 investors) issued at $2.50 each. This provides a post-money valuation of $5.625m if we apply the $2.50 share price to all the shares issued at that time (1,850,000 + 400,000 = 2.25m).

The company had a further two funding rounds, Series A and Series B, in which it received US$7.5m and US$15m of investment respectively. The share price for these funding rounds was agreed at $5.00/share for Series A and $10/share for Series B. The price is rising each funding round, which suggests that the business is performing well, and investors are prepared to pay more for shares as the company is growing.

We can also see that an ESOP was set up for employees with 650,000 share options.

We can conclude from the cap table that the company has an up-to-date defined valuation for its equity (US$59m) and has carefully recorded all the ownership and investment in the company since its inception. A cap table is vital as it contains all the investors’ stakes and the funding rounds in which they participated. It is often reassuring for new investors to see that current investors (such as Park Place Venture Capital in this example) are prepared to invest in further funding rounds to support the company growth strategy. It also demonstrates ownership dilution as the founders owned 50% each initially, and then became diluted to a 15.7% holding respectively, but will have seen the value of this ownership rise.

Conclusion

A cap table is essential for a private company and a critical tool in the VC Process. Company management is responsible for maintaining an up-to-date record of the equity ownership in its company. It is also needed to evaluate how additional new shares and new capital raised may impact the company’s equity structure.  For VC investors, understanding ownership, preference and the valuation of the company before they invest is an important part of due diligence.  All shareholders will be keenly interested in their ownership percentage prior to an exit.

Additional Resources

Venture Capital

What is a Venture Capital Analyst

Venture Capital Trusts