A comprehensive guide on cap table management for startups
The simplest way to describe cap tables is the following parallel: imagine your startup is a Netflix series - the cap table is the equivalent of the credits that show up at the end of the episodes. Any startup founder should clearly understand their company's ownership. This is imperative whether you incorporate a new venture or due diligence to raise money.
An organisation's cap table is one of its critical records, as it illustrates the ownership of the enterprise's options and stock. A cap table that isn't managed efficiently leads to bad decisions and diligence problems in transactions.
Why are cap tables essential for startups?
Cap tables are critical because they show who takes ownership of the organization. In other words, it is a legal document that illustrates the equity structure of your startup. The cap table is crucial because:
The information allows potential investors to determine how much leverage and control they'll get for their cash;
Founders can quickly determine the percentage of their startup they can offer to investors;
You can present the organization's holdings and history accurately if there's an audit;
Actual investors can view who has control and use the information to forecast their position in the organization;
The information provides historical insight that impacts your startup's valuation when there's a fundraising opportunity.
How can you use cap tables?
A cap table includes factors like shareholder information, vesting schedules, ownership position, purchase price, and voting percentages. It takes the data related to capitalisation and turns it into a digestible format that helps founders make decisions at the executive level, such as calculating liquidation waterfalls, soliciting stockholder approvals and raising extra funding rounds.
Here are the primary uses of cap tables:
Understanding your equity
One critical use of cap tables is to illustrate how decisions influence the equity structure of the organization. Do you want to raise another funding round? Or are you looking to expand the staff option pool?
Either way, a cap table can show you how these things will impact your shareholder groups. If it's the first time you're raising funding, it's essential to figure out what you give up. The cap table will help you in this sense and illustrate the organization's new proposed structure.
Discussing equity distributions
When building a new organisation you use the cap table to put the enterprise breakdown in writing. Discussing equity distributions isn't a cakewalk, but it's an imperative conversation that should take place at the initiation of every business. Using a cap table will help you facilitate the discussion from the first day.
Managing staff options
When getting new employees on board, the purpose is to align their incentives with the organization's objectives. Stock options are an excellent way to do that, as they allow you to match employees' contributions with the proper amount of stock.
The cap table illustrates the number of authorized options and how many of them can be issued at a particular moment. Moreover, it lists how many options were used up to a point. When creating a cap table, you should ensure the options can cover a 12-month continuous period.
Term sheet agreement
Having a clear image of your organization's ownership structure allows you to perform a what-if analysis on a funding round. See what happens to the ownership stake and organization control at various valuation levels.
Also, evaluate other critical aspects - for instance, if new options are issued prior to or after funding. This allows you to gain insight into what you're satisfied with and where to draw a demarcation line.
Is there a suitable time for organizations to start managing a cap table?
Organizations should ensure they have a proper cap table handy from the beginning. When outside investors aren't involved, you can use Excel spreadsheets. However, after the first funding round, you should shift to cap table management software. Spreadsheets become inconvenient when you have to record employee stock options, investor stakes and ownership interests.
Using a dedicated platform for cap table management for startups is critical, as it helps you manage financing rounds, facilitates finance modeling and integrates multiple functions like accounting records and payroll systems. On the other end of the spectrum, using excel sheets can lead to errors. Moreover, it's a cumbersome process, as you have to track, maintain and update cap tables manually. Dedicated software is practical because it handles a significant part of the manual work, thus simplifying the process of issuing shares to investors.
Cap table management is a critical function of startup business strategies and due to the need for accuracy, automating the process is the best thing you can do. Here are some practices that can help you improve and maintain an efficient cap table management process:
Understand its basic formats and elements. A cap table includes several elements and formats and can take a different form depending on the organization's various stages of its evolution. While cap tables are simple initially, they evolve over time, becoming more complicated. To maintain an efficient cap table management process, it's critical to ensure you understand all its basics.
Acknowledge the value of executive alignment. In their essence, cap tables are designed to solve business problems. If you don't use them in the decision-making process, they don't serve their primary purpose. A cap table plays a significant role in the recruitment process. Equity is a considerable factor when hiring talent, and if you don't have a proper cap table, you'll often find yourself in inconvenient situations. You'll be confused about the number of shares you can offer to new employees, which will slow down the recruitment process.
Evaluate and utilize tools that help you better manage it. Once your business grows, it becomes impossible to remember all the information accurately regarding the financial statements. While in the beginning, it may be easy to document all the information in Excel, later on, you need better systems to manage the complex data.
Decide how much information you will disclose to your investors. There is no right or wrong answer to how much data you should share with investors. Offering a summary cap table is a standard practice, allowing investors to evaluate their ownership position for audit purposes and internal tracking.
Choose how transparent you want to be with your employees. Founders should determine the balance they feel comfortable with when disclosing information to employees. While some founders are straightforward about cap tables, others don't reveal too much and share equity information on a fundamental basis. What matters here is figuring out how to use the cap table efficiently to help your staff understand the things they should know.
