At the beginning of a startup's journey, founders own the startup's issued shares total. Every founder's ownership stake is represented as a percentage in the Capitalization Table. As startups grow, they opt for Series ABC funding or other investment avenues. Founders may create option pools. They may give share options to advisors, employees, and board directors as remuneration for their work. To receive capital, they may sign convertible debt with noteholders and investment term sheets. This leads to the dilution of shares. Startups usually maintain a capitalization table along this journey. It shows stakeholders' breakdown of equity ownership and the type of equity, e.g., common shares, preferred shares, etc. The sum of all equity stakes equals 100%. In this guide, we will look at the specifications of a Capitalization Table. We will show a good Capitalization Table and how it is calculated.
It is a sheet that is usually created by a startup company. It lists all the company's securities. The table shows each investor's ownership of the firm. It shows the overall value of their securities and the amount of dilution that has happened over time. Capitalization Tables are created before other company documents. This is done in the early stages of a startup or venture. The Capitalization Tables become complex after a few rounds of financing. They list the potential funding sources, initial public offerings, mergers and acquisitions, and other transactions. A Capitalization Table also contains many legal documents. This includes stock issuances, transfers, and cancellations. It also includes the conversion of debt to equity and other documents. The executives must manage all these documents and transactions accurately. It helps to show the events since its inception.
These tables are used by founders, investors, and investment analysts. They use it to analyze important events. These include ownership dilution, employee stock options, and the issue of new securities. You can work your way forward and back from there. A good Capitalization Table has the following characteristics. The founder owns most of the shares, or the founders own as much as possible. There is an ESOP of about 15%. There are not any prior rounds where investors acquired more than 30%. Ideally, investors own less than 50%. Also, no investors on the Capitalization Table have a bad reputation or maybe a potential conflict in the future. Capitalization Tables can be harmful. They can also be screwed. A lousy Capitalization Table can kill your fundraising, and it has many times. You will likely need to rerun to get the deal done, diluting your current investors. So, if you have done any angel round at a high percentage, that is not good.
Prospective investors and founders might try a recap. It is done with the existing investors. This is under the threat that there will be no more rounds if there is no recap. That works sometimes. Sometimes investors want to watch the world burn.
The firm's founders are listed first in the table. This is followed by other employees who own equity. Then, investors such as venture capitalists. Most firms use spreadsheets to create a Capitalization Table. The Capitalization Table should be designed in a simple layout. It clearly shows who owns certain shares. It also points out the number of outstanding shares. The most common structure is to list investors/security owners on the Y-axis. The X-axis lists the type of securities. Alternatively, a firm can use a spreadsheet template. This allows for the addition of information and figures related to their business. The first row should show the total number of shares. The subsequent rows should list the following:
There are usually two sections – valuation and ownership. In the valuation section, input the present value of the firm. Here we have taken it as $1 million. Then enter the current number of shares outstanding. We have taken that number to be 200,000. In the ownership section, enter the value of individual investor contribution. We have taken this as $100,000 for investor 1, $250,000 for investor 2, etc. Below is an example of a typical Capitalization Table:
|
Common Shares |
Preference Shares |
Price |
Capital committed |
% Ownership |
|
|
Shareholders |
|||||
|
Founder 1 |
300,000 |
0.01 |
3,000 |
30% |
|
|
Founder 2 |
200,000 |
0.01 |
2,000 |
20% |
|
|
Employees |
100,000 |
0.1 |
10,000 |
10% |
|
|
Series A |
100,000 |
1 |
100,000 |
10% |
|
|
Options |
300,000 |
30% |
|||
|
Total |
900,000 |
100,000 |
115,000 |
100% |
For example, issuing new shares of existing security, transfer of shares, and changing stock options for employees. It includes the exit of crucial shareholders, new shareholders, and employees' termination and retirement. An updated Capitalization Table helps to make informed decisions based on the current information. US firms use their Capitalization Tables as the only system recording stock ownership. Capitalization Tables can be used as a formal legal record of equity ownership under US laws. Thus, it must be continually updated to reflect any changes in the stock ownership. Let us look at an example. Assume a VC is asking for 10% with an investment of $1 million. So the firm is valued at $10M. The firm already has 100,000 outstanding shares. It is split 50-50 between the founder and an angel investor.
How many new shares do the new Series A VC get with the investment? Their new ownership stake can be calculated as follows. New Ownership Stake = New Shares / (Old Shares + New Shares). Solving for their new shares. New Shares = Old Shares * Ownership Stake / (1 – Ownership Stake). Now applying the assumptions. New Shares = [.10/(1-.10)] * 100,000. New Shares = 11,111. Checking the calculation, we can see their shares represent 10% of the new firm.
11,111 / (100,000 + 11,111) = 10%
This is the actual ownership percentage. Accounting ownership varies from economic ownership. The latter is the percentage of ownership available to equity. In the example above, the VC invests $1 million for a 10% stake. The firm's ownership was previously split 50-50. The split was between the founder and an angel investor. Now let us allocate the proceeds. We assume the firm sells for $5M five years later. This is roughly half its initial valuation. Some additional background information. Series A Preferred shares. They have a 1x non-participating liquidation preference. The conversion ratio of preferred to common is assumed to be 1:1. The Series A investor must first decide what to do. They may take their preference. This amounts to 1x their initial $1 million investment. Or they can convert to common shares and take their pro-rata share of the proceeds. Preference amount = $1 million
Conversion amount = 10% of $5M = $500K. The VC will prefer a 1x multiple of invested capital. This means they at least get their money back.
But this would be a loss on a time-valued basis. The angel investor and the founder would each get $2M. What if the firm mentioned above was to sell for $100M? The investor would convert to common shares in this case. They would receive one-tenth of the proceeds. The angel investor and founder would get $45M each. Round modeling is a table or chart. It shows how new finance rounds will impact the current Capitalization Table. This may cause dilution in the existing shareholdings. So, potential new financial rounds will affect the shareholders.
Financers like to know about the changes in the previous financing rounds. Investors may have questions that the Capitalization Table can answer. They will want to know the overall impact of their investments on the other investors. They want to avoid any litigious situations. Investors also want to ascertain the liquidity rank. They want to sit at the top to be paid back before other investors if a liquidity event occurs. Most firms are becoming transparent about Capitalization Tables with their employees. This helps in retaining well-performing employees. It keeps them motivated to continue serving the company. Executives want to know the payouts of their ownership percentage. Firms that are transparent and organized have higher chances of retaining their employees. This is true even when they face financial distress.
Capitalization Tables are used as a formal legal record of ownership. They assist in determining the amount of taxation also. Suppose the Capitalization Tables are not updated continuously. In that case, the firm or its employees may end up paying excess taxes. Suppose the firm submitted fewer taxes than required. They may end up shelling out high penalties for avoidable mistakes. The sale proceeds are divided among shareholders when the company decides to sell the business to another company. The Capitalization Table outlines how much each shareholder gets and in what order. An updated Capitalization Table helps eliminate lawsuits and disagreements arising from the distribution of proceeds.
It is crucial to have precise records of the shareholders of your company. It is equally important to follow the relevant regulations. Mismanagement of the company's shares could put you in legal troubles and tax liabilities if you or your employees received earned compensation from it. The IRC 409A is the regulation for conducting a formal company valuation. This must be determined if your company wishes to get investors through financing. Share-based compensation plans, such as stock option plans for the company employees, are also essential. The ISO 1000K outlines the number of options that can vest during a particular year to qualify for particular tax treatment. The ASC 718 is a requirement in the measurement accounts. Those accounts measure and record the issued equity-based compensation. The measurement is done in terms of the company expenses. Rule 701 is an exemption from the requirement to register equity-based compensation with the SEC over 12 months. 83(B) election is about the restricted stock awards and should be finished in 30 days of a specific grant. There are more taxes and other regulations for the shares. However, these listed requirements are an essential component to consider for your Capitalization Table.
It is vital to keep all this information for the company's shares and owners up to date. You can see the details of the Capitalization Table. It provides the basic information about the company shares, options, warrants, and convertible notes. The Capitalization Table can also ensure that the company is adhering to the various regulations surrounding the company shares and organizing all the shareholder agreements within the company.
