A cap table is critically important for emerging companies, but it can quickly become very complicated. A cap table (short for “capitalization table”) is a list of the ownership shares in a company, along with SAFE, warrants, options, and other convertable securities. It provides one-stop visibility to the company’s overall capital structure as well as detailed information pertaining to each stakeholder. It can list each owner’s legal name and address, and will spell out how much was paid for equity, calculate the percentage of ownership for each investor on an “as-issued” and “as-converted” basis.
A company’s cap table is important for several reasons. First, it fulfills some critical legal and tax requirements, enabling tax accountants to produce accurate filings and delivering up-to-date information to investors regarding the status of their stake in the company. Further, cap tables along with their terms and conditions, are a key input to any 409A valuation and carry a significant tax impact once these shares are exercised or sold. Investors typically want to understand how much control they have over the company, forecast potential payouts, and calculate dilution under various possible future scenarios. Finally, any leadership team evaluating term sheets should understand the economic impacts prior to completing any stock purchase agreement.
With an accurate and up-to-date cap table, potential new investors can also gain an understanding of how much control they would have based on the terms of the deal, while founders can understand the dilutive impact for accepting any new capital. Employees, officers, and other stakeholders can assess the potential value of their shares and/or options in real time and from their own device. With an accurate cap table, existing shareholders can determine how much of the company to offer an investor for a given amount of new capital, without excessively diluting their own holdings.
Cap tables can also serve an important function in managing company growth. In small startups, equity compensation is often a critical factor in attracting and retaining key talent. If HR needs to make an offer to a prospective new hire, they’ll need to understand how much is available in the option pool, and how much they can afford to allocate as part of the offer. If you don’t have an updated cap table to hand, then you won’t have an answer to those questions, and the hiring process may move more slowly than it otherwise would.
It is critically important the cap table always be accurate and updated. Unfortunately, cap table management can often fall into that category of items that are “important, but not urgent”. As such, an updated cap table won’t be a high priority, until suddenly it is, and often on a Friday afternoon. Then, there is usually a scramble to update information, recalculate values in the cap table, and provide the necessary information to investors, tax attorneys, or employees.
Growing Pains for Cap Table Management
A cap table often begins as a fairly simple proposition: some founders with common stock and potentially a few advisors with equity grants. Many companies just starting out manage the process in a spreadsheet program such as Microsoft Excel. It doesn’t take long, though, for the process to become unwieldy. As the company takes in new rounds of investment and as new employees join the organization, that cap table beginning as a simple spreadsheet can quickly turn into a complicated web of formulas, dates, and flows of capital.
Keeping it up-to-date can become challenging. As the cap table becomes more and more complicated, the likelihood of errors increases significantly which could reflect poorly on any team sharing this information. Moreover, managing multiple versions of the cap table spreadsheet can lead to information that is out of sync, potentially confusing and ultimately inaccurate.
These kinds of problems emerge as changes occur in the company and complexity increases. You must record each new investor, often using different valuations than those reported for earlier investors. If you offer new hires options or shares as part of an equity compensation package, those hires introduce even more complexity into a capitalization table. When those same employees leave, with or without vesting shares or exercising options, you need to update the spreadsheet again.
Finally, there are liquidity events such as mergers, acquisitions, or initial public offerings; in which founders and early investors cash out part or all of their ownership stake in the company. These events can be especially complicated because different shareholders may be entitled to different payouts, resulting in a need to recalculate shares and percentages accordingly. This may require a technique known as “waterfall analysis” to figure the amount of proceeds and the resulting ownership stakes for each investor.
The Critical Importance of Getting Equity Management Right
As your company grows, it is imperative that record-keeping be accurate, timely, and complete. Good, clean record-keeping becomes critically important to meet legal and tax obligations and maintain positive relationships with investors.
There are multiple events that could potentially trigger the need for updates to your company’s cap table. Many are related to equity compensation, such as grants to new employees, employee terminations, or option exercise events. Others pertain to investor relationships, fundraising, and 409A valuations. Employees and investors alike are critical to the success of your company, so keeping accurate records and providing them with the information they need is essential.
There are several stakeholder groups that will need to see a cap table on a fairly routine basis. For some investors, it may be a contractual requirement that cap table information be shared regularly. At the same time, there are also confidentiality issues. How do you develop the reports necessary to share the right information with the right people, without revealing any data that should not be shared?
Selecting the Right Equity Management Software
As your company grows, it becomes less and less realistic to continue managing your cap table in a spreadsheet. To avoid the lack of version control and lack of automation associated with spreadsheets, growing companies should seek out the right tools to do the job properly. Perhaps just as importantly, business leaders should not wait until things get too complicated before they take action. The time to bring equity management under control is when things are still working well, not after they have broken.
Certent Equity Management provides private companies with complete and accurate control over the equity administration and capital management process. As your company grows through various rounds of funding, through IPO, and potentially even the complex world of public company equity and reporting management, Certent can scale with you. Start your business off on the right track.
To find out how Certent Equity Management from insightsoftware can simplify your cap table management, contact us to request a demo.