Cap Table Planning 101: 6 Tips For Startups
As an entrepreneur, you want to start a business because you have this amazing idea that you want to bring to the market and share with the market. And as your company grows, the way you manage your business should also evolve to enable strategic and well-informed decisions for stability and expansion.
And one of those necessary business evolutions is the proper planning and managing of a capitalization table.
What Is A Capitalization Table?
A capitalization table, or cap table, is a literal data table recording of all the shareholders of your company, including the founders, investors, and any advisers or employees who are involved in your business plan and own shares in your company.
The cap table shows your company’s ownership structure. It provides a clear and in-depth representation and analysis of ownership percentage, equity dilution, and equity value at each funding round for your business.
There are various reasons why you should have a cap table. However, all the reasons can be broadly classified under ‘decision making’. Startup business owners and entrepreneurs are continuously making decisions. And they need accurate capitalization information to make sound decisions.
Whether they’re looking for new financing options or simply identifying if there are enough shares to offer a new employee option, a cap table provides accurate and well-organized information that allows making well-informed decisions.
Tips To Plan And Manage Your Startup’s Cap Table
Now that you understand what a cap table is and how it can help your decision-making, here are some cap table planning and management tips to follow.
- Understanding The Basic Formats And Elements
The cap table comes in various formats and tables. It can be viewed as a table, spreadsheet, or chart, varying for every business at every stage of growth.
That said, you should understand its most basic form. A cap table should list all the equity stakes in your business, including stock options, common stock, and preferred stock, and outline all the ownership details for such securities.
You also need to include other elements such as transaction history, which includes the transfers, sales, and exercises of options, conversion of debt to equity, and transfer restrictions, among others.
In general, you want the cap table to show the overall capital structure of your business at a glance. It should also show the detailed ownership information for each series and class of outstanding stock.
- Invest In The Right Tools
Cap tables may look simple at the starting stages of your business, but they’ll naturally evolve and become more complicated as your business matures.
In the beginning, you can start by building your cap tables with an Excel spreadsheet. However, as your business grows, so does the information in your cap table, making it more complex and confusing to manage.
In this case, you need better and more automated systems in place. Using cap table management software can provide better capabilities and version control than basic spreadsheets.
The ultimate purpose of a cap table is to help executives make informed decisions, while cap management allows for organized and updated information as well as in-depth analysis of data for sound decision-making.
- Determine Equity Grant Sizing Rules
When planning your cap table, you want to determine an equity compensation plan early. This way, you have the numbers you can go back to when hiring new employees and make it easy to have those conversations when bringing employees in.
For instance, you can define that C-suite executives can get 1% to 5%, while those in manager or director-level positions can get 0.25% and 0.5%, respectively. You can further refine these rules by segmenting the equity allocations by the department.
- Add Possible Dilution Details And Pre-Money Valuation
These two elements are important during your planning phase: dilution and pre-money valuation.
Dilution happens when a business issues new shares, which decreases the ownership percentage of existing shareholders. This can happen when a business raises extra equity capital, and existing shareholders are often at a disadvantage. Thus, when planning and maintaining your cap table, you need to add a detail of possible dilution effects from adding new shareholders.
Meanwhile, a pre-money valuation refers to the equity value of a business before it receives the cash from a new funding round. Adding a pre-money valuation to your cap table while planning can provide a reference to the fair value of the shares as well as how much you should be looking for with new investors.
In addition, this pre-money valuation also offers new investors a reference on how much ownership they’ll receive if they invest in your company.
- Keep It Updated
Think of a cap table as a living document. As your startup grows and expands through rounds of funding, your cap table also grows and changes with that progress. That said, one of the best practices for cap table management is to ensure that all information is up-to-date by recording every detail as it occurs.
You want to update any changes, such as transfers of shares between shareholders, bringing in a new shareholder, repurchasing or buying back shares, stock option exercises, and all other transactions, regardless of how small.
Every transaction can affect the total ownership of a business that each individual shareholder has. Thus, it would be best if you had a current and updated cap table that allows for accurate and smart decisions about your company’s share.
- Delegate Someone To Manage The Cap Table
As mentioned in the previous point, the cap table needs to be updated as changes occur. That said, as a business owner, you don’t always have the time to work on your cap table.
This is where an outside counsel or your legal team can be valuable. Delegating cap table management to your lawyer can help you stay on top of every change and reduce errors while allowing you to focus more on growing and building your business.
In addition, planning and maintaining an accurate cap table will require the ability to read, translate, and understand legal documents into formulas and numbers. Thus, it’s best if you can delegate it to those with the necessary skills to ensure the most accurate business decisions.
Conclusion
For startup business owners, it can be overwhelming to plan and develop a cap table. However, by following the above tips and best practices, you can better plan, manage, and leverage your cap table to gain actionable business intelligence for your growing startup.
