Startup to Exit: How do Cap Tables Work in a Startup Lifecycle?

Oct. 17, 2017

BY TARA MATAMOROS CARTER & SINÉAD CHEUNG

Cap Tables for Startups

The capitalization table or cap table is key to maintaining a clear and detailed record of startup ownership. In order to understand cap tables and the role they play within a startup lifecycle from inception to exit, read the details we've put together for you in the post below. For informative cap table readings, we suggest you reference Brad Feld's introductory post on cap tables and Gust's how to value your technology startup.

What is a Cap Table?

Fred Wilson, a New York based VC, writes that a cap table stores all major stockholders of the company, as well as option holders. Similarly, according to Investopedia, a capitalization table specifies stock, warrants, options, and other investment ownership in a startup. As the company grows, the cap table becomes more complex and includes new funding sources, mergers and acquisitions, among other transactions.

With that said, you may be wondering if a cap table is really necessary for your startup.

To put it succinctly, without a cap table, any forms of deal-making from hiring an employee to raising capital, would not be possible. Knowing who owns what, and invest in what portion, determines and illustrates how much financial risk and reward is involved.

Now that you have a solid foundation of the purpose of a cap table and the importance of having one, let's delve into how it works in the startup lifecycle.

How a Cap Table Works in a Startup Lifecycle

To understand the role cap tables have in a startup lifecycle, let's assume that you've identified three phases to your lifecycle:

Inteception - growth - exit

Cap Table Phase 1: Inception - Starting a Company and Economic Ownership

Alright, let’s assume that you and your founders created an amazing company. There’s traction now, and the work you put in is finally paying off. So who gets what? How is economic ownership distributed?

When starting a company, it is quite common for founders to perform a fixed, even split of equity in their company early on in the process. This is also similar to how founders set up employee option plans. However, as time progresses, economic ownership of a company becomes more dynamic and fluid. This is common, and a direct result of the shifting roles and responsibilities within the company as well as the number of stakeholders involved.

Reiterating Fred Wilson’s post on equity ownership, you must understand your company’s valuation. This is the price point in which you would sell your business. Valuation can take the form of your recent exit offer or it can be a public market analysis. Secondly, look over your organization. How you are segmenting yourself and your employees. How many levels are there? Senior Level? Director Level? Junior Level? Finally, how much weight do you want to place in said roles?

Once you determine your company’s valuation, org structure and the multiplier for each role (a subjective number based on how much weight / substance you and your founder place in each role), plug them into the following formulas:

Dollar Value of Equity Offered = Salary x Multiplier
Shares Outstanding = (Dollar Value of Equity / Your Company’s Valuation) * Available Shares Outstanding

Below is an example of this formula in action, applied to your fictitious company and the roles you’ve identified within:

Your Company Valuation: $25M USD

Available Shares Outstanding: 10M

Employee Organization:

Employee organization

Cap Table Phase 2: Growth - Funding a Company and Dilution

After economic ownership by role has been identified, gears shift and you can now focus on raising capital for your company.

Understanding equity dilution is an important, and complex concept. As time progresses, it is important to understand ownership over your own company will become more fluid than fixed over time.

So what exactly is dilution in reference to equity? Dilution in the decrease in existing economic ownership of a company as result of new equity issuance. “In a more general way, dilution is the loss of value of existing shares due [to] new equity terms.” This typically happens when a startup looks for funding to grow a company. Sometimes, this means adding a new co-founder to the roster, and/or hiring new employees.

A common misnomer many new startups believe is that their pre-money valuation determines their percentage ownership of the company. This isn't the case. Dilution needs to be factored in to see what you really own.

Equity dilution quote

Let’s say a company’s initial cap table looks like this:

Employee organization

You'll notice that your cap table has a column for common shares. This refers to securities that are representative of part ownership of your company. Since they usually carry voting rights, company founders usually hold common shares.

Referencing the table above, founders, Jane Doe and Joe Smith, each own approximately 50% of the company. As a group, they own 100%.

As the company grows, let’s say Jane Doe and John Smith are now looking to raise new capital. In exchange for funding, there is commonly the issuance of new equity. The amount of dilution is subsequently dictated by the per-share price of the amount the company raises.

Here is what it looks like the company raises $1,000,000 at $10 / share from a venture capital firm, say from VC Firm A:

Cap table example

As you can see, the founders now collectively own only about 50% of the company. The founders’ ownership stake decreased, but they also now have $1,000,000 to grow the business.

Following in line with Josh Maher, an angel investor, “a clean cap table and solid equity compensation can be worth more than the million dollar investment alone.”

The cap table will help you quote

With that said, you'll likely end up including variations in your cap table that show what happens in various scenarios, such as if more shares are issued. In running scenarios, you'll want to include clear calculations of valuation and percentages of ownership both pre-money, post-money, and fully diluted post-money. Before committing to an investment, investors will want to see exactly what they will own in all possible scenarios.

Cap Table Phase 3: Exiting - Selling Your Company

Congratulations! Your company is now successful and there is mutual interest between you and another larger firm for an exit. How much will you be walking away with? Leveraging the same table covered earlier, the below outlines steps to determine your company’s and the stakeholder’s exit return.

In determining the exit valuation, you’d first begin by breaking down the price per share.
After price per share is identified, it is utilized in identifying exit value for both the founders and the investor.
Exit Price / Total Number of Share = Price per Share
$20M / 10M = $2 per Share
Founder Number of Share x Price per Share = Founder Exit Value
8M x $2 = $16M
Investor Number of Share x Price per Share = Investor Exit Value
2M x $2 = $4M

Your Turn to Develop a Cap Table

In theory, a cap table is not a difficult task to maintain. However, after adding new employees and additional investors into the pool, keeping track of the table manually in a spreadsheet can become cumbersome. There are automated tools you can fall back on, such as capshare and eShares, should the manual upkeep become too much of a pain.

Whether your table is maintained in a spreadsheet or within an automated software, key is keeping the table up to date. As additional rounds of investments ensue, and your company dilutes further, it's important to keep track of all changes in your cap table. This way, at any given moment, you know how much you own, the equity dilution and the value of equity. And in turn, investors are then able to understand what they are buying. Good luck!

BY TARA MATAMOROS CARTER & SINÉAD CHEUNG
BUSINESS DEVELOPMENT, BUSINESS STARTUP, STARTUP LIFECYCLE, CAP TABLE