What are Capitalization Tables?
The capitalization table is a very important record for any startup company. These tables provide a clear and unambiguous report of who owns and controls what percentage of the startup’s shares. It is considered to be the final and irrefutable record that provides details about the ownership of the company.
Since decisions involving financing, sale, or restructuring of a startup tend to be complex and require several parties to sign off, the capitalization table proves to be an important source of information. The study of these tables can help investors realize which stakeholders they need to convince in order to obtain a sign-off.
In this article, we will understand what capitalization tables are and why they are considered to be so important in the context of a startup organization.
Components of a Cap Table
The cap table of any startup company has several key components. The details of some of these components are mentioned below:
- List of Investors: A cap table generally provides a list of investors in the rows of the table. It is advisable to break down this list to the most granular level. For instance, instead of mentioning that all the founders have a 30% stake in the company, the cap table should enumerate the individual stake that each of the shareholders has. The same should be done for employees as well. Investors always have to be listed separately since they are different legal entities and cannot be grouped together
- Details about the Shareholding: The cap table is supposed to mention details about the number and type of shares which are being held by each stakeholder. The type of shares being held by each of the stakeholders is very important. The details of how different types of shares affect decision-making are mentioned below. The date of issuance of shares can also be considered to be important in some cases.
- Valuation of Shares: Since the shares of the startup company are not publically traded, their valuation is not available on an everyday basis. However, whenever there is any transaction that affects the valuation of shares, the new value must be updated into the cap table.
Different Types of Shares in a Startup Company
Normally, the number of shares which exist for a company should be fairly easy to calculate. However, when it comes to startup companies, this calculation is not so simple. Startup companies tend to use different types of stocks and individual investors may have the capability to completely change the shareholding pattern of the company.
- The cap table needs to have explicit details of the number of shares that have been authorized by the company. All of these shares may not be issued. Some of these shares may be pending for future issuance
- Outstanding shares refers to all the common stock and preferred stock which the company has issued until now
- Preferred shares need to be listed separately since they may have several features. For instance, participating preferred stockholders may be entitled to more dividends than regular stockholders
- All types of securities which can be converted to common stock with voting rights also need to be listed. The cap table must clearly mention the number of shares that may come into existence tomorrow. There are several types of debt and preferred shares issued by startups that can be converted to equity. Once this conversion happens, the voting power within the startup may witness a significant change
- Options and warrants which are issued to employees, as well as other stakeholders, also need to be taken into account while preparing the cap table
The presence or absence of voting rights for each of these categories should be clearly mentioned. The cap table should show what the fully-diluted shareholding pattern of the startup company would look like.
Advantages of Cap Table
Cap tables are considered to be an important document because they are used by several different stakeholders for different purposes.
- The founders can use the cap table to conduct a what-if analysis when they go for funding rounds. They can see the impact that different valuation levels will have on the ownership and control of the firm. The cap table acts as a ready-reckoner which aids in quick decision making.
- Existing investors use the cap table to understand the extent of dilution that their holdings will undergo if the company issues more stock in the option pool or if they go for another round of funding at a different valuation
- The cap table is also used by the founders when they are hiring new employees. This is because offering stock options is a routine part of hiring in a start-up company. However, the founder must be aware of the exact number of stocks that are authorized and available in the option pool before they can offer them
Maintaining the Cap Table
The preparation of the cap table is not a one-time activity. In the case of start-up companies, employee options, and the founder’s stock keep on vesting over a period of time. Also, the valuation of the company may change from time to time. Hence, the founders must ensure that the cap tables are maintained with up-to-date information to enable quick and accurate decision-making.
The bottom line is that cap tables are important for several reasons. They can be considered to be proof of ownership and provide a dashboard-type view of the different stakeholders of the company.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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