Equity distribution in the initial days of a startup is simpler. Usually, it is based on mutually agreed terms between partners and is straightforward enough to be tracked on an excel sheet. However, soon enough the startup begins to grow and the number of stakeholders with equity stakes increases. Then developing and properly managing a capitalization table becomes essential for evolution.
The capitalization table or Cap Table is the data that lays out the capitalization for the company. Capitalization is the total value of shares the company has and how those shares are divided. The cap table provides a detailed and intricate breakdown of the shareholdings, the holders, and the projections. It includes the specifics of a company’s equity ownership capital including preferred equity shares, warrants, convertible equity, etc. The cap table essentially helps startup founders illustrate ownership stakes in the business and highlights which securities are outstanding.
The Cap Table is somewhat similar to a balance sheet – it reflects the financial position at a specific point in time. Apart from showing the ownership and accompanying economic and voting rights, the Cap Table also provides valuable information such as ownership position, shareholder information, rights to purchase additional future equity, voting percentages, vesting schedules, purchase price, etc.
The Cap Table takes all the information related to capitalization and distils these into a digestible format that can help startup founders take strategic business decisions with greater ease. With good Cap Table management, startup founders can confidently make executive decisions for issuing ESOP grants to new hires, raising additional financing, soliciting stockholder approval, or calculating liquidation waterfalls for liquidity events.
The Importance and Complexity of Cap Table Management
The Cap Table looks different for every company at different growth stages. While in the initial days of the startup the Cap Table is simple, as the organization matures, the Cap Table also evolves and naturally, starts to become more complex.
Along with listing out the equity stakes, Cap Tables also need to include other elements such as transaction history and legal restrictions such as transfers and transfer restrictions, sales, the exercise of options, and conversion of debt to equity, amongst other things.
The Cap Table should always correctly reflect the organization’s overall capital structure, detailed ownership information for each class, and series of stock outstanding and must always be current and up to date.
The design of the Cap Table should be such that it provides valuable information that supports business decisions. If the startup is unable to use the Cap Table to make decisions by the executive team, then it does not serve its core purpose. Cap Tables provide a way to gain alignment on matters important to the organization and find use in many organizational aspects. In hiring, for example, without an accurate Cap Table, companies will be in a quandary over how many shares can be allocated to new hires. This can unnecessarily slow down the recruitment process. Using a Cap Table helps HR provide routine feedback on equity packages to help improve or maintain competitive compensation for all employees.
A Cap Table also needs to be detailed. But how much detail is enough? To begin with, it can be easy to ignore the Cap Table at the beginning of the startup journey. It is easy to rattle off the Cap Table details or have the same stored in excel sheets. But as the organization grows, this information becomes more complex and exhaustive. Scalability and traceability can be big problems with spreadsheets as information increases. Excel spreadsheets also do not provide a single source of truth and can be prone to human error apart from being time-consuming to maintain.
Formatting a Cap Table accurately can also be a source of pain and frustration, especially in the absence of the right skills and knowledge. As such, having the right Cap Table management systems become imperative.
A Cap Table is also considered a legal document (while, strictly speaking, it is not so) since it spells out the company’s equity structure. Mistakes within the Cap Table, therefore, mean mistakes in the company’s ownership documentation. Managing the Cap Table well right from the inception of the company becomes extremely important since tracking spreadsheets to track ownership interests alongside investor stakes and employee stock options only becomes complex as the company matures.
Cap Table Management Matters
A well-managed Cap Table brings in immense clarity. It can help companies attract investments and prevent or effectively manage further dilution of stakes. It helps:
- Current investors see who exercises control and forecast potential pay-outs and dilution under specific scenarios
- Provides insight to potential investors to evaluate the degree of control and leverage that could be maintained during negotiations
- Gives employees clarity on the real-time value of equity stakes and stock options
- Build the capacity to leverage historical insight to negotiate current valuation for new funding opportunities
- Navigate the regulatory and compliance conundrum by improving audit capabilities and providing detailed and accurate and well-organized information on history and holdings
- Help existing shareholders determine what percentage of stake to give to new shareholders in exchange for contributed capital
Putting off fixing the Cap Table management can prove to be a costly mistake. Remember that the cap table will inevitably need to be managed sometime. And then the company will need to find skilled (read expensive) lawyers and professionals to manage this task and conduct the repair job. Startup founders always need to be on top of their Cap Table management to avoid headaches in the future.
Having a comprehensive Cap Table management solution that addresses all the challenges of Cap Table management and provides a single source of truth and a comprehensive history of ownership eliminates most of the woes associated with its management. It also makes sure that the Cap Table works for the company and becomes a strategic asset.
Connect with us to see how our equity management platform helps you do Cap Table management with ease.