Every business, big or small, needs to know who is invested in their company and how much of that company they own. The cap table is an essential business document that communicates vital information about a company’s current equity structure.
What Is A Cap Table and Why Is It Important?
The cap table is a spreadsheet businesses use to track who owns what percentage of a company. For example, if two people decided to start a restaurant, they would each own fifty percent. At this point, the cap table is very simple.
Let’s say the restaurant owners are so successful that they decide to open multiple locations. They hire more employees and bring in new investors. The investors will expect shares in the company in return for their investment. The owners also put aside a portion of the available shares for new and existing employees. At this point, a rough outline of who owns what (saved in an email somewhere) won’t do the trick.
Cap Table Contents Overview
Cap tables can include different details for each company, but each one is composed of the same essential things: who has invested in the company, how much they’ve invested, and what percentage of the company they own.
A basic cap table example would list the ownership structure of a company. This would usually be in the form of a simple Excel spreadsheet. It would include the names of the shareholders, the number of shares they own, and the percentage of ownership they have in the company.
A slightly more complex capitalization table example would include the option pool. An option pool represents the number of shares set aside as part of the company’s equity compensation plan. It lays out the number of shares in the option pool, the percentage of the total shares outstanding, and the number of shares that have been granted to specific employees.
Larger or more established companies would typically need to use a fully diluted cap table. This takes into account all of the potential sources of dilution, such as outstanding options, warrants, and convertible securities. It displays the ownership structure on a fully diluted basis.
How Are Cap Tables used?
Cap Tables for Founders
As a founder, your capitalization table will be the main source of truth when it comes to making decisions. It will provide guidance on future investments and who should have a say in the direction of the company.
Some examples of when you’ll refer to your cap table include:
Raising Funding
You will use your cap table to forecast how new investments will dilute your ownership percentages, valuation and value per share. You can also use the cap table to determine how much of a percentage you are giving the new investors for the amount of money they’re contributing, which becomes the basis for negotiating.
Track Complex Stock types and schedules
If you have stock options, warrants, or convertible equities as part of your equity structure, an up-to-date cap table is a vital tool for keeping track of everything. You’ll need to track how many shares of the various stock options have vested over time. You will also have to adjust the cap table when an employee option holder leaves the company.
You can use your cap table to monitor restricted stocks, transfers, and repurchases. This can become a full-time job as your workforce grows or you go through a period of high turnover.
Hiring for major roles
Putting together a compensation package to retain and attract executive talent usually involves a significant equity offer. Your cap table allows you to see the pool available for employee stock options and structures your offers accordingly.
Taxation
You are required to disclose if you own 25% or more of any entity, with some exceptions. This becomes especially important when you have foreign activities. Your tax specialist can use your cap table to determine what foreign filing obligations your shareholders need to be aware of. This is necessary to avoid pricey tax penalties (upwards of $10,000 per late or incomplete filing).
There are also tax concerns when employees exercise their incentive stock options. When corporations transfer company stock to a shareholder, they are required to file Form 3921 to inform tax authorities.
Many companies incorporate in Delaware to save on corporate income taxes and are required to file and pay a franchise tax. This filing process requires an up-to-date cap table.
If you’re the founding member of a company, you’ll want to talk to your tax advisor about the 83(b) election. The 83(b) election comes into play when your stock dramatically increases in value. If this happens, you and your co-founders won’t have to pay an annual tax unless the company is later bought, merged, or goes public.
Cap Tables for Investors
An investor relies on the cap table to provide a point of reference for the company’s existing capital structure. They will use the cap table to judge whether a company is suitable for their investment portfolio.
Some elements that an investor may look for in a cap table for startups include:
Founder Equity Level
The more shares a founder retains in a company, the more likely they are to push for financial success. A founder who owns 20% of their company is likely to be more committed than the founder whose shares have been diluted to 1%.
Other Investors
The cap table shows potential investors who have already invested and how much of the company they own. If an investor they respect has bought a large share in a given company, it might persuade them to also invest.
Alternatively, a small group of insiders or investors may have a controlling share in a company. This may deter potential investors if they feel their vision for the company doesn’t align with that group’s philosophy.
Future Dilution
A cap table allows an investor to analyze how the current total stock options, warranties, and convertible equities will affect their ownership stake. If all of these elements converted to shares tomorrow, where would that leave their investment?
It also lets potential investors see if any preferred shares have been issued. Preference shares usually come with terms and preferences, such as liquidation preferences or anti-dilution protections. These can impact the potential return on investment.
Cap Tables for Accountants and Auditors
During series A and B funding rounds, companies release stock compensation expense reports on the equity they issue to employees. Accountants and auditors come in to help manage interrelated formalities, such as compliance.
Whether your business is a corporation, proprietorship, or partnership, an outsourced accounting provider such as inDinero will need to know your ownership distribution. This helps them set up the owner’s equity section of your balance sheet, thoroughly understand who the stakeholders are, and determine how to allocate profits and losses accordingly. They will also use the number of shares and the allocation dates to create proper journal entries in your books.
Who Manages Your Cap Table?
The cap table management role depends on the size of the company. During the early life of a company, it’s generally the founders who update and reconcile the cap table. This may change at the seed round stage, with a legal specialist or team brought in to ensure compliance.
As the company goes through various rounds of funding, any agreement with new investors will undoubtedly require a legal document. A lawyer will create these official documents outlining the terms of that agreement. The document will outline how much each person owns, the amount of money they’ve given you, and how much it will be worth down the road. The lawyer will then help you update your cap table accordingly with the terms of the agreement.
As the company grows, a controller or CFO takes on the responsibility of managing the entire process internally along with a full-time, in-house attorney.
Download our Cap Table Template
At inDinero, we understand that cap table management is a vital part of running your company, but it can be a daunting task. Interested in learning more about cap tables and how they can help you run your business? You can download a cap table template here that will provide a head start on filling out this important business tool.
Do you need to consult with a CFO to get more out of your cap table? Are you looking to identify the tax implications of your current equity structure? Contact us today, and we would be more than happy to discuss your situation.
