12
Jared Verzello
Contributor
Jared Verzello is a startup and venture capital lawyer and GM of Atrium Seed where he guides companies through formation, fundraising, hiring, and managing board meetings.
More posts by this contributor
Pre- and Post-Money SAFEs: Choosing the right one for your startup
Founders start a company because they have an idea they want to bring to market.
As their company gains traction and matures, the way in which they manage their business needs to evolve to enable strategic decisions for growth.
Developing and properly managing acapitalization table(cap table) is one such necessary business evolution.
In this context, capitalization is the sum and itemization of all those who hold equity in the company or the right to receive equity in the future.
Tracking these items through a central means helps illustrate the ownership stakes in the business and what securities the company has outstanding.
For a first-time founder, it can be overwhelming to develop a cap table and make all related decisions.
However, with the right resources and adoption of best practices, founders can better manage, maintain and leverage their cap table to provide actionable business intelligence and management.
For better business intelligence, look to your cap table
In many ways, the cap table is akin to the balance sheet in the sense that it represents the company position as of a certain point in time.
The balance sheet shows the company assets and liabilities.
The cap table shows the company ownership and accompanying economic and voting rights.
The cap table includes factors such as shareholder information, ownership position, rights to purchase additional equity in the future, vesting schedules, voting percentages and purchase price.
It takes all of the material information related to capitalization and summarizes it into a digestible format to help founders make executive-level decisions for soliciting stockholder approvals, issuing grants to new hires, raising additional rounds of financing, calculating liquidation waterfalls for a liquidity event, etc.
When it comes to how much founders need to own the cap table, think about it this way: Not every CFO needs to build out the financial statements.
However, every CFO needs to have a high degree of confidence that their financial statements are accurate — with systems in place to ensure accuracy so they can spend their time using the financial statements to make strategic decisions.
The same is true for founders& involvement with their cap tables.
Most companies rely on competent legal counsel to maintain their cap table and provide their executive team with actionable information in a digestible format.
Here are six best practices that help founders improve and maintain an effective cap table management process.
1.
Familiarize yourself with its basic elements and formats
There are many different elements and formats of a cap table.
Viewed as a spreadsheet, table or chart, the cap table can look different for every company at every stage of its growth.
While the cap table tends to be simple in the beginning stages of the company, it will naturally evolve and become much more complicated as the company matures.
At a basic level, the cap table should list the equity stakes in a company, including common stock,preferred stock and stock options, and outline all of the ownership details for these securities.
Other elements include transaction history and legal restrictions, such as sales, transfers, exercises of options, transfer restrictions and the conversion of debt to equity, among others.
The cap table should show the company overall capital structure at a glance, as well as detailed ownership information for each class and series of stock outstanding (see an example at the end of this article).
Most importantly, it should always be accurate and up to date.
2.
Recognize the importance of executive alignment
At its core, the cap table should be designed to help solve business issues for you.
If you&re not using it to make decisions as an executive team, then it not serving a core purpose.
The cap table is also critical to your legal team, so certain aspects may be primarily for their use, but if the company management doesn&t find the cap table helpful, that is a problem.
Creating good habits early on will serve you well as the business grows.
A good example of this is its role in the hiring process.
Equity is a key consideration in talent recruitment and retention packages.
Without an accurate cap table, you&ll find yourself in situations where you have to routinely ask yourself how many shares you can offer to a new hire, which can unnecessarily slow down the hiring process.
However, if you can use the cap table as a way to gain alignment on such matters, you can begin to use it to solve actual business problems.
Rather than argue about which equity package to grant a new employee, your HR team can provide routine feedback on standardized equity packages to help improve or maintain competitive compensation.
3.
Evaluate and implement tools to help you manage it
When it comes to understanding how detailed your cap table needs to be, compare it once again to the financial statements.
In the early days of the business, financial statements don&t necessarily feel as valuable as they do in later stages of growth.
They aren&t as critical to the business — yet — because it not hard to recreate it whenever you need information to make a decision.
However, as the business matures and grows, it becomes more difficult to recreate the financial statement on an ad hoc basis, and virtually impossible to hold the information accurately in your mind.
The same holds true with the cap table: In the beginning, you might be able to rattle it off the top of your head or have it documented simply in Excel, but as you grow, the information becomes more complex and you need better, automated systems in place.
As with financial statements, creating good habits early on will serve you well as the business grows.
Using cap management software provides better capabilities and version control than spreadsheets to manage this process.
Free software, such ascaptable.ioand Carta are great starting places for early-stage founders.
Carta also provides additional features to manage your more complex cap table.
Because the cap table ultimate purpose is to enable the executive and legal teams to make informed decisions, safeguards on administrative access and version control are critical features to consider when choosing which tool or application to use.
4.
Determine and delegate ownership of the cap table
As you model new rounds of financing and analyze the impact on stakeholders, cap table management becomes a significantly valuable activity.
This is where your legal team or outside counsel becomes even more advantageous to you as a founder.
Delegating cap table management to your lawyer can further help you stay on top of critical changes and minimize errors, while enabling you to focus more on building and scaling the business.
Creating and maintaining an accurate cap table requires an ability to read, understand and translate legal documents into numbers and formulas.
It is best to rely on the expertise of your legal team for this to ensure the most accurate business decisions are made.
Your cap table should be well-managed, well-understood and up-to-date.
We frequently see founding teams make seemingly small mistakes, such as adding an individual name to the cap table before an equity grant has legally been made.
This may lead one to believe that more stock is outstanding than is technically the case and can create errors when calculating the number of shares to be granted to subsequent stockholders — or miss making the grant altogether, which can have unfortunate tax consequences for the stockholder and potential liability for the company.
Order of operations is critical to legal workflows and it best to leave the day to day cap table maintenance to your legal team.
5.
Decide how much information to share with investors
When it comes to how much cap table information you should disclose to your investors, there isn&t a right or wrong answer.
Commonly, providing investors with a summary cap table is a fairly standard practice.
That allows investors to calculate their ownership position for their internal tracking and audit purposes.
More often than not, investors don&t receive an itemized list of every shareholder or investor in the company.
While preferences differ on this point, many of our clients prefer that any company-related discussions are directed to the executive team so they can address and control messaging.
Of course, in many instances investors will know which of their peers have also invested, but sharing detailed equity positions, contact information and individual employees& equity stakes is less common.
In Carta, investors generally have portfolio views with visibility into all of their companies.
They might send you a request for access to your cap table so they can add you to their portfolio.
In this scenario, the summary cap table is the most common approach people default to for the investors.
If an investor feels strongly about receiving detailed cap table viewing privileges, they can make their case to the company, which may consider the request on an individual basis.
Major investors will typically have specific, private contractual rights to get regular financial statements and cap table updates.
They might even have a representative who is a board observer or board member, in which case, they will have access to the information they want, as agreed to in the equity financing paperwork.
6.
Choose how much to share with employees
Understanding the appropriate levels of information about your cap table to share with employees is another top consideration for founders.
The key to this is determining the balance that you, as a founder, feel comfortable with in terms of employer transparency.
Some founders choose to be transparent about their cap tables and others opt not to disclose much and provide equity information on a need-to-know basis.
The important part here is determining how you can best use the cap table to help your employees understand what they need to know.
For example, employees with equity want to understand what their payout is if the company sells.
Regular communication or resources that provide employees with access to their holdings and options is a great approach to help motivate employees and improve talent retention, but can have unintended consequences.
For example, most companies will have their common stock valued after each round of financing.
Some founders will want to share this number with the team so that people can understand that their stock is appreciating.
That is very exciting and motivating — so long as everything is going well.
However, if the stock appreciation is not meeting the team expectation (whether reasonable or not), then providing that information can significantly decrease morale.
For this reason, the vast majority of companies choose not to disclose this information to the broader team.
Get proactive with your cap table
Your cap table should be well-managed, well-understood and up-to-date.
Fortunately, the management process doesn&t need to become just another headache: With the proper considerations, communication, resources and ownership, you can put the correct processes and legal team in place efficiently, and effectively manage your cap table so it continues to help you scale your business — rather than slow it down.
Sample cap table
This table represents a simple cap table showing a hypothetical breakdown of seed preferred stock, Series A preferred stock, common stock and the available option pool.
All content presented herein is for informational purposes only.
Nothing should be construed as legal advice.
Transmission and receipt of this information is not intended to create, and does not constitute, an attorney-client relationship with Atrium LLP.
There is no expectation of attorney-client privilege or confidentiality of anything you may communicate to us in this forum.
Do not act upon any information presented without seeking professional counsel.
