Cap Table for Startup: Keep Track of Your Shares
Introduction
It may seem natural for founders – to have a separate file where all shareholdings are listed and updated from time to time. However, I have experienced the opposite when this file is usually neglected or forgotten. Founders might ask “Why do I need this if there are only two shareholders with 50% in the company?” First, to simply be transparent with your partner. And, what is also important, to keep track of your Finance and Legal as even minor transactions might affect the cap table. For example, your partner wants to hire a VP of Engineering and agrees on the 0.5% ESOP with a 4-year vesting period. This is the case when you already need to update the cap table; below I will explain why.
Shareholdings Structure in the cap table
The capitalization table (the cap table) is a very simple document. It’s a spreadsheet – in Excel or any other software of your taste, where the share percentage for each shareholder is specified and the total valuation is defined. That’s simple. Sometimes, if there are different classes of shares, the class of share for each shareholding is also mentioned.
The cap table convenience comes into play when there are more than 1 shareholder. I usually advise structuring the shareholdings into an easily divisible number of shares that can be attributed to a certain percentage without fractions. For example, if you plan to have 4 shareholders, it’s always better to issue more shares – 1,000,000 than 1000 shares. In this case, you will have the exact amount of shares to create a share option pool without a need to round the shares themselves or to offer to a new investor. And they can be divided into any percentage with those unnecessary fractions. Try to calculate 7,35% out of 1000 shares and out of 1,000,000 and you will get an idea.
Thus, the first draft of your cap table will probably look like this:
| Equity Percentage | Total share | |
|---|---|---|
| Shareholder 1 | 40% | 400,000 |
| Shareholder 2 | 20% | 200,000 |
| Shareholder 3 | 30% | 300,000 |
| Shareholder 4 | 10% | 100,000 |
| Total number of shares | 100% | 1,000,000 |
Company Valuation in the cap table
The Company valuation is the total value of all business assets calculated in one of the generally accepted methods. Depending on the evaluation approaches, the valuation may or may not include the human resources value (The Scorecard Approach), possible risks (Risk Factor Summation Method), revenue projections (Discounted Cash Flow Method), etc. We will discuss the most common valuation methods for tech startups in further articles.
What should be noted now is that company valuation is essential while creating the cap table structure. Without it, you will only have a share number which does not show you a lot in terms of how much your stake in the company costs.
The valuation also goes together with price per share (the PPS) – actual market price, not par value as defined in the Registration or Incumbency Certificate. The PPS is calculated by dividing the total valuation by the total number of shares. It’s not necessary to put the PPS into the cap table as this will not give a lot of useful information because all early-stage startups are private companies, not public and PPS is not changing often. However, it’s a good practice to implement a separate line mentioning the PPS. When the potential investor asks for the cap table, they would have a full picture.
So, let’s say the post-money company valuation is $10,000,000 (valuation after investment). Then the next cap table iteration will be as follows:
| Total Share | Equity Percentage | Valuation | |
|---|---|---|---|
| Shareholder 1 | 400,000 | 40% | $4,000,000 |
| Shareholder 2 | 200,000 | 20% | $2,000,000 |
| Shareholder 3 | 300,000 | 30% | $3,000,000 |
| Shareholder 4 | 100,000 | 10% | $1,000,000 |
| Total | 1,000,000 | 100% | $10,000,000 |
* The XYZ Company PPS = $10
Share Classes and Investment Rounds
When the company has been incorporated, the basic shares are issued to form the share capital and to be distributed among the shareholders. These basic shares are called Common Shares or very often Ordinary Shares (we will call them Common Shares).
The Common Shares are created to reflect the initial shareholdings of the earliest founders. This class of shares usually bears voting rights. When the investment is made by existing shareholders or new investors, the preference Shares are issued against this new investment. Preference Shares quite often do not hold voting rights, however, they entitle their holders to the liquidation preference.
Liquidation preference is a multiplicator that indicates how much the participating shareholder is getting in case of the liquidity event (which can also be acquisition) on top of the initial stake. For instance, if an investor puts $1mln into the startup under 1.5x liquidation preference, at the time of company liquidation the investor will receive 1.5mln of their initial investment. I will go over the liquidation preference in more detail when I describe statutory documents for founders.
Sometimes, preference shares hold the voting rights as well and still have the liquidation preference. This is done to differentiate the investment rounds, however, to keep the holders of the preference shares on equal terms when it comes to decision-making with common shares investors.
If your startup is early-stage, you will definitely be fundraising. This means involving new investments from existing or new investors and closing investment rounds. You might start from the earliest Seed round – Series AA. Further rounds will create Series A shares (later Series B, Series C shares), or sometimes share class inside another share class (SAFE Series AA shares). All these share classes are preference shares with attributed rights as described above.
So the cap table with investment rounds might look like this:
| Common Shares | Series AA Shares | Series A Shares | Total Shares | Equity Percentage | Valuation | |
|---|---|---|---|---|---|---|
| Shareholder 1 | 200,000 | 200,000 | 400,000 | 40% | $4,000,000 | |
| Shareholder 2 | 100,000 | 50,000 | 50,000 | 200,000 | 20% | $2,000,000 |
| Shareholder 3 | 100,000 | 200,000 | 300,000 | 30% | $3,000,000 | |
| Shareholder 4 | 100,000 | 100,000 | 10% | $1,000,000 | ||
| Total | 300,000 | 350,000 | 350,000 | 1,000,000 | 100% | $10,000,000 |
How to Manage cap table
The cap table management is not rocket science. All you need is a person responsible for this. The best fit for this role is a General Counsel or CFO. The first one is always on top of all shareholding changes and organizes all communication regarding corporate matters between shareholders. The other one keeps track of the company valuation, audit, and financial statements which impacts the cap table directly (remember PPS and DCF).
However, you as a founder should decide and appoint one of them to mitigate any uncertainty and mess when you will need an up-to-date cap table right away but it’s not in place for some reason.
The best approach I recommend is to use the shared document for cap table management with access for the CEO, General Counsel, and CFO. It can be organized via straightforward Google Spreadsheets (my favorite) or specific online tools for cap table management (Yanda, Carta, various cap table simulators that calculate all shares % very conveniently).
The only disadvantage of those online tools is that sometimes when you have very specific share classes (Series A SAFE Conversion Shares etc.) they may not have the appropriate fields for such types of shares and no functionality to insert them manually. Plus the case may be when such tools have certain formulas incorporated by default to calculate shares and as the final result, you may get not what you’ve expected because custom share classes have been messed up during calculation. For this scenario, you must be cautious and pay attention to the details when inserting share classes.
It’s worth saying that the cap table contains strictly confidential information. Even when you share it with shareholders or investors, make sure the access is granted to certain people for a limited period, and the only way to copy it is by making a screenshot. But from this, no one is protected.
Conclusion
To make the shareholdings structured within your company – apply the cap table. This will keep shares organized and the person responsible for its management will always update the entries. The share classes depend on the amount of investment rounds and may look terrifying. Use cap table management tools and don’t forget about valuation as it will give much more sense when presenting a cap table to the shareholders or investors.
Author – Yuliia Verhun, IT Lawyer
All intellectual property rights to this Article belong to Yuliia Verhun.
