Regardless of how great your business idea sounds; one thing venture capitalists will always want to see before making any investment in your company is your cap table. To save yourself from headaches down the road, it’s important to be thoughtful with your cap table from the very beginning.
What is a Cap Table?
A cap table is a record of a company’s equity ownership, which, depending on how a company is organized, might be called shares, stock, units, or interests. For the sake of simplifying, we’ll use shares within the context of this post. In addition to keeping record of who owns what, the cap table provides a means by which founders and investors can calculate their percentage of ownership and equity dilution under different scenarios, such as an additional round of funding.
Taking a Dip in the Option Pool
Cap tables are important for multiple reasons:
- They allow investors to better understand what they’re buying into
- They help all shareholders (founders included) keep track of their ownership stake as the company grows and raises additional funding
To begin, it may look something like this:
We’ll start on the left side of the table. During term sheet negotiations, the founders and investors will have to determine these three numbers:
- Pre-Money Valuation
- Post-Money Valuation (Pre-Money Valuation + Total Investment)
- Price-Per-Share (Pre-Money Valuation / Pre-Money Shares)
Now let’s do some math. In this example, the startup’s post-money valuation is $3,000,000:
$2,000,000 (pre-money valuation) + $500,000 (investor 1) + $500,000 (investor 2) = $3,000,000 (post-money valuation)
Our price-per-share, $0.25, is determined by dividing the pre-money valuation by the number of pre-money shares:
$2,000,000 (pre-money valuation) / 8,000,000 = $0.25 (price-per-share)
Now let’s move on to investor shares. This can be calculated by dividing the total amount an individual investor has invested by the price-per-share:
500,000 (total invested) / $0.25 = 2,000,000
In this case, each investor put in $500,000, so they would each get 2,000,000 shares. This brings total shares up from 8,000,000 to 12,000,000.
To get post-money percentage ownership for each investor and founder, you take the number of investor shares and divide that by the total number of post money shares:
4,000,000 / 12,000,000 = 33.7% (Founder 1 % Ownership)
4,000,000 / 12,000,000 = 33.7% (Founder 2 % Ownership)
2,000,000 / 12,000,000 = 16.6% (Investor 1 % Ownership)
2,000,000 / 12,000,000 = 16.6% (Investor 2 % Ownership)
As you can see, everything stems from term sheet negotiations. You can also see how adding additional investors begins to dilute founder ownership.
Equity Dilution in Startups
There is truly no singular way to set up a cap table; what matters most is that it’s well-organized and easy to read. At a minimum it should include:
- The name of the shareholder (the way it appears on the security instrument)
- When it was issued
- The number of shares issued
Typically, the order of entries will descend from the oldest at the top, newest at the bottom. Some startups may choose to order their cap table from largest stake to the smallest.
As a company grows, the cap table will become more complicated, growing to include preferred shares, exercised options, and additional rounds of funding. A common investment structure you’ll see in venture capital is investments via a special purpose vehicle (SPV), which can help keep your cap table more organized.
To keep everything in line, it should be updated consistently. Events such as issuing new shares, selling shares, or increasing the option pool all impact equity value, and the cap table must be updated accordingly to reflect these changes.
Common vs. Preferred: Pros and Cons in Private Equity
If you’re ever in doubt about your current cap table or need help creating one, there are plenty of resources online that offer samples you can download. There are also services such as Carta or Capshare, which offer automated cap table management. It may be in your best interest to reach out to your attorney, as they will have the best grasp on your unique situation and will be able to provide tailored help to keep your cap table accurate and up to date.
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.