It’s the summer of 2017.
You decide to open up an ice-cream store, selling organic, naturally flavored ice-creams. As an entrepreneur, and hungry to scale, you realize that you need more money to grow your firm’s operations. At this point, you decide to offer ownership and voting rights in the company in return for a cash injection. This process is called equity financing and is the most common way firms generate cash to fund their expansion efforts.
As you offer equity in your company, you begin to dilute your ownership – meaning you are no longer the sole owner of the firm. Initially, this shareholder dilution seems relatively easy to follow (and at the start it is), however, as the business grows and grows, and tens of investors begin to show interest in your revolutionary dessert options, tracking the ownership becomes a mathematical puzzle as shares start to be sold, transferred, redistributed, or cancelled. This is where Cap Tables come in.
What is a Capitalization Table?
A Capitalization Table (or Cap Table) is an electronic, documented flow of ownership from company incorporation to present day operations. A Cap Table highlights the “who-owns-what” percentage of your company, calculated in terms of the number of shares.
The anatomy of a Cap Table breaks down relatively simply:
- Who has invested in your company [ Your Shareholders ]
- How much they have invested in your company [ $ contributed to Financing Round Total ]
- How many shares they purchased from you [ Their Ownership Percentage ]
- The legal documents associated with the financing round [Compliancy and Auditability Track]
Unlike a spreadsheet, a cap table consolidates both the share ledger information (which can typically be tracked through any spreadsheet software) and the contractual documents associated to the information. If your records are kept manually, through Excel or similar, any law firm you hire to facilitate the raise will have to go through the documents by hand to and ensure everything balances out. More documents mean more manual labour, which means more billable hours and a higher overall cost.
How do you use a Cap Table?
Cap Tables when Capital Raising
Often Cap Tables can consume quite a lot of your company executives’ time, especially while preparing for a financing event and trying to document shareholder ownership. However, these tables are exactly what an investor needs to help understand the returns of investing in your business.
As fundraising is one of the most important milestones of a growing company (arguably the make-or-break moment), it is beneficial for you to be aware of your company’s Cap Table and to keep it up-to-date in order to reduce inefficiencies while dealing with investors.
Investors’ interest lies in only one thing: their potential return. They want to understand exactly what % they would receive for the amount that they invest. From this perspective, investors can project out potential financing scenarios, and work backwards from what they think could the company is potentially valued at. This affords negotiation leverage for both investors and founders (and is something commonly seen on shows like Dragons’ Den or Shark Tank).
Moreover, presenting investors with a cap table consolidates the material into an easy to use, professional layout rather than stacks of paper documents (that honestly nobody wants to have to rummage through)
Cap Tables when Issuing Stock to Employees
Employee Incentive Plans (offering ownership stakes to employees) are a hook to help attract and retain the top industry talent for your firm, yet they can become incredibly complex to implement. Not only do you have to preempt how many shares you will need to set aside for the incentive plan, but you need to understand how to track the number of shares which have vested (issued and in possession) and any transfers or repurchases.
Using a Cap Table lets you document your vesting schedules and automatically issue and track shares without having to recreate the table from scratch. Moreover, any transferred shares, cancellations, and repurchases are documented and incorporated dynamically into the table. Needless to say this aids in streamlining your operations.
Cap Tables when laying out an Exit Strategy
Potentially the most important aspect to a cap table is the insight it provides you into your company’s exit strategy. It determines the amount each shareholder receives if (and hopefully when) your company either IPOs or gets acquired. The ownership percentage directly relates to the value received. If your company is sold for $10M and you held 10% equity, then you would receive $1M. When investors are considering investing in a company, they often request to see the company’s Cap Table. This is to understand how dilution is affecting overall valuation for expected exit values and leads to a waterfall analyses. In turn, the calculation models exactly how much capital returns to each shareholder under a variety of exit scenarios.
Ultimately, when you consider improving your market strategy (be it developing a vegan-friendly ice-cream options or competing against gelato in Europe) and you consider raising capital, it may be wiser to first focus on your Cap Table. With your cap table in order, and hypothetical financial scenarios considered, it will be easier to sweeten the deal with investors and to show them that your soft-serve business is a true