Cap Tables

A companion presentation to your copy of Poland, S. 2016. Cap Tables, 1x1 Media LLC

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What is a cap table?

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A document, usually a spreadsheet, that tracks who owns how much of a company

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How is the cap table used? To answer Qs like...

• How much equity does each founder own?
• How much money has been invested in the company over time?
• Who owns what type of shares - common / preferred?
• How big is the options plan for the company, and who are the major option holders in the company?
• What is the valuation of the startup at each funding stage?

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Cap tables track and calculate...

• Impact of advanced investment structures (e.g., convertible debt and warrants)
• Equity or stock options granted to major service providers (e.g., software developers, marketing agencies, law firms)
• What-if scenarios for each funding round, including raise amount, valuation, and resulting dilution for funders and existing shareholders face
• Exit scenario planning, including how much money each stakeholder will make if the founders sell the startup
• Valuation and share prices showing how valuation has changed over time, any down rounds or bridge funding rounds that suggest delays in company traction

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Do I need to worry about a cap table? Yes, if you’re

• Agreeing on the startup’s equity split between co-founders
• Building your funding roadmap
• Beginning discussions with outside investors
• Getting early funding in the form of convertible debt
• Planning exit scenarios and other “what-if” scenarios
• Establishing an employee stock incentive plan

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Getting started on your cap table

Establish the number of authorized shares at formation

1. Authorize enough to cover early needs such as founders, option pool, and early-stage investors (angels, F&F)
2. Make sure you don’t create fractional ownership of shares (“Dude owns 75 ⅕ shares!”)
3. Keep the share prices in expected ranges (see next slide; you were going to do that anyway, right?)
4. Pro Tip: Start with 10,000,000 shares authorized.

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Question: How do we track convertible debt?

Convertible debt is an important source of financing for very early stage ventures

Convertible debt lets us take a formal investment in our startups at a point in development when every dollar really helps without prematurely setting a pre-money valuation. But “debt” shows up on balance sheets!

Question: Are there any formal ways to account for convertible debt on a cap table? What sources are there that can tell an entrepreneur how to account for non-equity contributions of capital to a new venture?

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Convertible Debt on Cap Tables

Convertible debt is initially recorded as a liability on the company's balance sheet rather than on the cap table because it's a form of debt. However, it has implications for the cap table once it converts into equity, usually during a future financing round (triggered by specific terms like a qualified financing event, a specific date, or a decision by the holder). Here’s how it impacts the cap table upon conversion:

1. Conversion Mechanism: Convertible notes convert into equity at either a discounted rate or a valuation cap. This means when a future equity financing round occurs, the debt will convert into equity at a predetermined price per share, which is often lower than the price offered to new investors in that round.
2. Effect on Ownership: Once converted, the shares issued are added to the cap table, diluting existing shareholders but not affecting the total number of authorized shares unless additional shares need to be authorized to accommodate the conversion.
3. Tracking: It’s essential to track the conditions under which the debt will convert in the notes accompanying the cap table. This includes noting the discount rate, interest accrued, and the valuation cap.

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Non-Equity Contributions

Non-equity contributions, such as sweat equity, intellectual property, or other forms of non-cash contributions, can also be tricky to represent on a cap table. Typically, these contributions are valued and converted into the equivalent number of shares, reflecting the contributor's ownership percentage. Here's how they are generally handled:

1. Valuation of Contributions: The value of non-equity contributions must be agreed upon by all founding members. This could be based on fair market values, previous transactions, or expert valuations.
2. Issuing Shares: Once valued, the contribution is converted into shares at the current share price, and these shares are added to the cap table.
3. Documentation: Detailed records of the valuation process and the basis for it should be maintained. This is crucial for legal purposes and future funding rounds.

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Calculating number of shares issued and share price

When an investor offers you money in exchange for a percentage of ownership in the company you can convert that expression into number of shares you will issue the owner PLUS a share price

X is the number of shares already issued (pre-money)

Y is the new number of shares that are issued (post-money)

Z is the percentage of ownership the investor wants for her money

Y = X + Z(Y) to get the new total number of shares

Y - Z = the number of shares the investor gets; the investment amount divided by the number of shares the investor gets determines the SHARE PRICE

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Calculating number of shares issued and share price

Give me an example. OK, founders have issued themselves 2,000,000 shares. An investor offers $500,000 in exchange for 20 percent of the company.

• X is the number of shares already issued (pre-money) = 2,000,000
• Y is the new total number of shares that are issued (post-money) = what we’re trying to find
• Z is the percentage of ownership the investor wants for her money = 20 percent
• Y = 2,000,000 + 0.2*Y; 0.8*Y = 2,000,000; Y = 2,000,000/0.8 = 2,500,000
• Y - X = the number of shares the investor gets = 2,500,000 - 2,000,000 = 500,000 shares to your investor
• Share price equals $500,000 investment/500,000 shares = $1 per share

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Resources for Entrepreneurs

Several resources can guide entrepreneurs on how to manage their cap tables:

1. Books and Guides: Books like "Venture Deals" by Brad Feld and Jason Mendelson provide detailed insights into financing techniques including managing a cap table. AND THE BOOK ASSIGNED FOR THIS TOPIC!
2. Software Tools: Cap table management software like Carta, Capshare, or Pulley helps track shares, convertible notes, and equity grants over time.
3. Online Courses: Platforms like Coursera or Udemy offer courses on startup finance that cover cap tables and equity management.
4. Legal Advice: Consulting with a startup lawyer can provide tailored advice based on specific business situations and ensure compliance with relevant laws and regulations.

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Founders Pocket Guide Cap Table

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Now go over GovWorks pro formas

Authorize 10,000,000 shares. Par X authorized = 0.0001 X 10,000,000 = $1,000 (yet this amount won’t appear on your cap table, just your # shares)

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Some terms we need to know (balance sheet)

Par value is the face value of a stock stated in the corporate charter.

• Shares usually have no par value or very low par value, such as 1 cent per share; par value has very little relation to the shares' market price.
• Some states require that companies cannot sell shares below the par value. So most companies set a par value for their stocks to a minimal amount. For example, the par value for shares of Apple, Inc. is $0.00001 and the par value for Amazon stock is $0.01.
• Par value appears in the balance sheet in the stockholders equity section

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Some terms we need to know (balance sheet)

Additional paid-in capital is what investors pay “on top” of the par value of shares of stock to own them. Think of it as the “premium” investors pay for the value you’ve built into your startup

• Additional paid-in capital (APIC), is an accounting term referring to money an investor pays above and beyond the par value price of a stock
• Often referred to as "contributed capital in excess of par”
• APIC occurs when an investor buys newly-issued shares, directly from a company, during private equity rounds or in its initial public offering (IPO) stage.

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