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Cap Table Defined
A cap table is a detailed document that outlines the ownership shares of a company in terms of either the number of shares or the percentage of ownership each shareholder holds. It provides transparency in ownership and facilitates financial decision-making, making it an essential tool for sophisticated investors. By the end of this article, you will clearly understand why maintaining an up-to-date cap table is crucial for attracting capital investors.
Cap Table Structure
Stakeholder List:
A hedge fund cap table is a register of all owners of equity. Yes, initially, this may be only you, but as you continue to grow, adding more investors, partners, and employees who have earned shares, it will need to be updated regularly.
Equity Ownership Percentages
The capitalization table clearly outlines each shareholder's percentage of the company. This percentage is determined by dividing their shares by the total shares available in the funding round.
Classes of Shares
Common Shares:
Typically held by founders, employees, and early-on investors, these shares generally have voting rights.
Preferred Shares:
This share designation is often a requirement by venture capitalists and institutional investors. The preferred class of shares may have a liquidation preference over common stock. Such shares would also have anti-dilution provisions to protect the VC capital.
Share Options
Options address the rights of employees or advisors to buy shares at predetermined prices, which are dictated by ownership periods, i.e., the vesting schedule.
Valuations
Each share has a nominal assigned value derived from the fund's total capitalization divided by the number of issued shares. Share valuation is affected since the share price changes as the fund receives capital. With each round of investing, the price per share and the overall valuation usually increase. New shares are issued at higher prices than in previous rounds, a trend which is indicative of the potential and growth of the company and is referred to as an 'up round.'
Attracting Fund Capital
When striving to secure additional capital for your newly launched fund, it is not solely about showcasing your sales and promotional capabilities. You are persuading astute investors (accredited and qualified purchasers) to choose your fund from various other opportunities, which can be a real uphill push when you are new to the scene.
Successful investors seek investments that prove the fund manager has invested time, effort, and money to structure the fund properly. Doing so and providing complete transparency can be the pivotal factor that sways investors towards your fund. You may have observed instances where funds with lower historical returns attract more capital than others touting higher returns. The underlying reason for the influx of capital can be attributed to investors' confidence in the solid, reliable management personnel and business operations behind the scenes.
While less seasoned investors might be solely focused on the potential of better-than-market returns, seasoned investors and venture capital funding sources prioritize prudent risk management. Demonstrating your alignment with these priorities represents a significant step towards arranging a face-to-face meeting and gaining their trust.
The Importance of a Cap Table for Venture Capital Funds
To understand the equity distribution, venture capitalists need a clear picture of the company's ownership structure. A cap table is a viewing portal for VCs to monitor ownership percentages, track portfolio success rates, and determine if further capital investment is warranted.
A venture capitalist (VC) considers share dilution as a crucial factor. They examine capitalization tables to understand how previous funding rounds have impacted shareholders' ownership stakes in the company. This analysis helps them gauge how future fundraising rounds might influence their ownership percentage. Don't be surprised if, during your discussion, the VC requests a share dilution protection clause.
Can you appreciate why it's essential that you regularly review and update the cap table? A properly modeled cap table ensures your projections and strategies are well supported. When evaluating your investment opportunity, investors and venture capital sources will expect you to have an organized and precise capitalization table.
Remember that venture capitalists are very thorough before committing to a decision. Of paramount issue are concerns over a fund's compliance and adherence to regulations, as they are responsible to their investors and will not risk losing their trust. A complete cap table also assures the VC that you are prepared for any regulatory reviews.
How to Create and Maintain a Cap Table
The capitalization table records ownership stakes, including shares and convertible securities, like warrants and options, and share-based compensation grants. The table gives a view of equity ownership by showcasing the distribution of shares or rights among owners, their market value, and the percentage of overall ownership.
Identify ALL equity holders, starting with yourself and any other founders—next, executives and key employees with equity stakes. Include investors by date or descending amount of invested capital and note any special warrants they received.
A hedge fund cap table is a register (think spreadsheet) of all owners of equity. Yes, initially, this may be only you, but as you continue to grow, adding more investors, partners, and employees who have earned shares will require regular updates.
The Role of a Cap Table in Fundraising
In the business world, a capitalization table displays the overall market worth of a company and its various parts, serving as a tool for VCs when making decisions that affect both market capitalization and the company's overall value. Securing additional capital for business expansion under favorable terms will necessitate an up-to-date cap table that accurately reflects the fund's financial standing.
The moment will arrive when it becomes necessary to engage legal and accounting specialists to perform the complicated work. That's a good thing, as your fund is growing steadily, and hiring these professionals will help ensure that your fund is fully compliant and ready to face any potential audit legal issues that could arise.
The Importance of Professional Help in Managing a Cap Table
In the early stages of your fund launch, creating and keeping your cap table up to date is relatively easy, but as you expand, it can become a real headache as many different activities take place. Examples would be new rounds of funding, share options to recruit skilled employees, and the inverse, rescinding an employee's share options upon their early departure.
Similarly, other factors include allowing options to lapse naturally or enabling an investor to utilize their options, such as changing them for shares or selling them outright. All of these scenarios ultimately impact the structure of the capitalization table.
Would your time be best spent talking with investors? In that case, it may be prudent to use services such as Carta or Capshare to automate tasks, minimize mistakes, and simplify updating the cap table as your organization changes; ultimately, you may find that the moment will arrive when it becomes necessary to engage legal and accounting specialists to perform the complicated work. That's a good thing, as it means your fund is growing steadily, and hiring these professionals will help ensure that your fund is fully compliant and ready to face any potential audit legal issues that could arise.
Understanding cap tables and effective management strategies is essential for success. By mastering cap table management, you'll have an edge in assessing investment prospects, negotiating deals, and enhancing the performance of your portfolio businesses. This knowledge will be valuable as you establish and expand your fund.
In Review:
- Upon the legal formation of your hedge fund, your number one priority should be creating the capitalization table.
- Make it standard operating procedure to add to your cap table every new investor or employee with share options. A growth and dilution model is necessary for future investors and VCs when making investment decisions.
- Note: If you struggle with backend recordkeeping, consider using an online service such as Carta or Capshare to automate the process or retain professional services. Sophisticated investors respect a fund that has their act together.
If you are interested in launching your hedge fund, you will discover a ton of helpful information by visiting www.fundlaunch.com/training.
There is a reason that over 900 fund managers trust Fund Launch as their go-to resource to hone their skills and grow a successful fund. Our real-world experience will help you shorten your time to market.
