Essential Cap Table Vocabulary, Structure, and Solutions

No matter the type, size, and stage of a business, there are certain terms and concepts which are essential for founders to know so that they can manage their cap table effectively.

• Pre-money valuation/post money valuation: The pre-money valuation of a business is its worth before any additional capital comes into play. Before investments are finalized, negotiations between company stakeholders and investors help determine the most suitable pre-money valuation for the company. The post-money valuation, on the other hand, is the worth of the business after the new money is invested (this value is normally higher).
• Common stock: Each common stock represents a share of ownership in the firm. Founders and staff own common stocks and have the right to vote on significant managerial decisions. On occasion, they may also be qualified for dividends. However, common stockholders are the last to get paid in the event of a liquidation or a payout.
• Preferred stock: This kind of stock is seen as a relatively safe investment. That’s because when a company is dissolved, the holders of preferred shares are the first to be given money and a share of the profits. Unlike common shareholders, they do not have the right to vote.
• Convertible notes: These notes act as loans, but they can be swapped for equity once the company reaches a predetermined milestone. With convertible notes, investors don’t need to determine the company’s value before investing. This is beneficial for startups, as it’s usually a tough job to accurately calculate your company’s worth in the beginning. Convertible notes are regularly employed by seed and angel investors.
• Stock Options: Employee stock option plans provide a contractual benefit that grants the right to acquire a certain amount of shares at a predetermined cost on a certain date. These are not stocks themselves, but rather options for acquiring them. This discounted rate is also known as the ‘strike price’ and is only available to employees.
• Warrants: Warrants are similar to stock options in that they give the holder the right to purchase a certain amount of stock at an established cost by a certain date. However, while stock options are typically granted to employees and other people who work for the company, warrants are used in business deals.
• Restricted stocks: Also known as letter stocks or section 1244 stocks, restricted stocks are often used in executive compensation plans. These stocks can’t be transferred, and usually have limitations on when they can be sold. To encourage long-term commitment from key executives, they are subject to a graded vesting schedule lasting several years.
• Authorized shares: The amount of shares a public company is allowed to issue is called authorized capital stock or authorized shares. This restriction is commonly included in the company’s articles of incorporation and is listed within the capital accounts of the balance sheet.
• Fully diluted shares: These are the total number of outstanding shares, including those that could possibly be converted in the future. This number incorporates not only the issued common shares, but also any convertible notes or employee stock options that could be converted in the near future.
• Outstanding shares: This represents the total number of shares owned by all shareholders. It includes any blocks held by institutional shareholders and stocks limited to executives but doesn’t include stocks that have yet to be used, which means the value of outstanding shares is not fixed and can change over time.
• Dilution: Issuing additional shares beyond those already in the market causes dilution of ownership. Founders can use the cap table to figure out the number of shares already held by different stakeholders (such as staff and investors) to gauge the level of dilution in the firm and plan for future dilution and its effects on current shareholders.

Cap Table Structure

Maintaining an accurate cap table and keeping all interested parties informed is a major responsibility. At the onset, it may be possible to do it manually, but as the business grows, new stakeholders join, and some leave, it becomes an intricate task with a high potential for human mistakes. Implementing proper cap table tracking ensures accuracy and reduces the risk of errors by automating updates to reflect new equity issuances, transfers, and other changes. Let’s review the two major ways to manage cap tables: Excel sheets and cap table software.

Using Excel Sheet for Cap Table Management  

A typical approach for startups is to maintain a basic cap table structure in an Excel sheet. This is a good option for startups because they have few employees and little equity to worry about. Plus, Excel sheets are incredibly versatile, allowing companies to tailor their cap table to their specific needs.

However, the complexity of keeping track of equity ownership increases as more investments and hires come on board. Eventually, it becomes necessary to switch to equity management software. At some point, a spreadsheet-based cap table simply can’t handle the expansion of a business. The growth of your business is exciting, but it can also increase the opportunity for errors in your cap table, which can have serious legal consequences. To help your company avoid these legal troubles, you must involve a law firm that will ensure you adhere to IRS and SEC regulations.

The Benefits of Using Cap Table Software

Cap table software—like the solution my employer, Astrella, offers—provides an incredibly convenient and user-friendly experience when compared to Excel sheets. Even if your business isn’t complex from the start, it’s better to employ cap table software immediately so that all equity operations are efficient from the beginning. Also, your top investors will most likely choose to work with enterprises using cap table software, as it’s much better at giving an up-to-date and accurate view of ownership.

Excel vs Cap Table Software

Given the limitations of cap table management with Excel spreadsheets, the biggest benefits of using equity management software are:

• Significant cost and time savings: Investing in cap table software not only covers the cost of the license itself, but it also lessens the amount of money spent on finance and legal professionals, communication between stakeholders, and the risk of fines due to manual errors.
• Automations: Cap table software eliminates the need for manual updating and tracking of each step after a company’s valuation, new stock issuance, or liquidity. It’s programmed to update the records and notify the stakeholders according to their equity possession.
• A single source of truth for equity ownership: Cap table software acts as a centralized source of information which is easily accessible to all stakeholders. Everyone can have their own personalized account, meaning that the data is always up-to-date and accurate. Unlike cap tables on Excel sheets, which different users can alter, software provides a standardized version that can be customized to suit the needs of each user.

For more information on cap tables, see my blog “Cap Tables 101 for Founders.”