Managing a cap table

In this video, Mintz Associates Brook Wong and Luke Jeagal explain what a cap table is, why it’s important, and some best practices for managing it effectively. For a copy of the cap table examples in the video, please refer to the linked spreadsheet Managing a cap table: Examples.

Transcript

[0:00] Managing a cap table

Hi. My name is Brook Wong, and I’m an Associate at Mintz.

Hi. My name is Luke Jeagal, and I’m an Associate at Mintz.

Welcome to our guide on capitalization tables. Whether you’re a startup founder or an investor, understanding cap tables is crucial for managing ownership and planning for growth. In this video, we’ll explore what a cap table is, why it’s important, and some best practices for managing it effectively. Let’s dive in. 

[0:29] What is a capitalization table?

So, what exactly is a cap table? In simplest terms, a cap table is a document that outlines the ownership structure of a company. It shows who owns what percentage of the company at a given point in time and may show the impact of changes in ownership.

[0:47] Why is a cap table important?

A well-maintained cap table helps track ownership, understand dilution, and model various transaction scenarios. Here’s why each is important.

[0:58] Tracking ownership

The most obvious use of the cap table is to get a snapshot of equity ownership in the company at a given point in time. This is typically broken down by type of security (for example, common shares, preferred shares, stock options), and shows the percentage that each holder owns in the company.

In the early stages of a company, this often starts off very simple, with perhaps just a handful of founders. As the company grows, the cap table becomes more complex, especially as stock options are issued to employees, when the company raises venture capital financing, or multiple rounds of venture capital financing 

In addition to tracking who owns what, a cap table is useful for determining the rights that each shareholder holds. For example, if the company needs a certain percentage of shareholders to approve a certain action, then an accurate cap table can help determine how that can be achieved.

[1:55] Understanding dilution

A question that shareholders often pose is “How will this dilute my shares?” For example, if there is financing and a new investor is buying shares, a pre-financing and post-financing cap table can help show the dilutive impact on each shareholder.

This may seem simple, but dilution calculations can sometimes get complex. For example, a common feature in preferred shares is something called “anti-dilution adjustments.”

Preferred shares are often convertible into common shares, initially on a one-for-one basis. However, preferred shares that have anti-dilution protection contain a mechanism whereby if new shares are issued below a certain price then the preferred shares are convertible into a greater number of common shares. This would reduce the dilution that preferred shareholders would face on a fully-diluted basis.

Financing will therefore not only add new shares to the cap table, but may also increase the number of shares that the preferred shares convert into.

[2:55] Modelling transaction scenarios

Perhaps the most important use of a cap table is for modelling transaction scenarios. It can be used to model the payouts to shareholders in the event of a financing or sale of the company. 

For an equity financing, when using a cap table to model different scenarios, a company may need to consider the impact on existing securities, such as anti-dilution protection or conversion mechanics found in promissory notes and SAFES.

For the sale of a company, the payments made to shareholders are often referred to as the “waterfall”. A purchaser may wish to buy a company for $X and the cap table is useful in modelling how that $X will “flow” to the shareholder base. This will take into account the various liquidity preferences, interest rates, and other features of debt or equity instruments that the cap table may have. It is important to properly determine the payouts to each group of shareholders in a transaction in order to avoid disputes later.

[3:50] Common mistakes and best practices

[3:52] Not updating regularly

The most obvious mistake is having an inaccurate cap table. For example, this can happen if option grants, executions, and/or expiries are not tracked properly. Regularly updating the cap table is essential to maintaining its accuracy.

[4:10] Not understanding pre- and post-money valuation

Another common pitfall is misunderstanding valuations during financing. Often, a financing transaction will be expressed on the basis of a certain valuation of the company. However, it is important that all parties to a transaction fully understand what this valuation is referring to. For example, an investor may want to invest $10 million for 25% of the company. The parties should clarify whether this means the investor will end up owning 25% after the transaction on a post-money basis or whether the company is currently valued at $40 million today and they are putting in $10 million more at that valuation on a pre-money basis.

Further, parties should clarify what the valuation of the company includes. For example, does this include all options that have been granted? All options that have been reserved for issuance? Preparing a pro-forma cap table can help investors and companies align expectations and clarify some of these issues.

[5:11] Conclusion

In summary, a well-maintained capitalization table is a vital tool for both startups and investors. It provides a clear picture of ownership, helps in understanding the effects of dilution, and supports complex scenario modelling, including ownership projections and exit strategies.

By avoiding common pitfalls, such as inaccuracies and misunderstandings of valuation, and adhering to best practices, you can ensure your cap table remains a reliable resource for decision-making and strategic planning.

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