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When it comes to managing venture capital funds, understanding the ins and outs of cap tables is absolutely essential.
Here at Fund Launch, we have helped launch over 300 funds. We know the steps involved, and we’re here today to bring some clarity.
Below, we will break down what cap tables are and how they work, outline the vital role they play in equity management, cover how they’re structured, explain how to create and maintain them, and point you toward some resources to get you started.
Cap Table Defined
A cap table (also called a “capitalization table”) is a comprehensive document used by startups to outline and manage the ownership stakes within the company, including all shareholders, such as founders, early investors, venture capitalists, and employees with stock options.
For those looking into managing venture capital funds, knowing how to read a cap table and understanding how they work is a primary skill in evaluating a startup's financial health and investment potential.
Cap Table Structure
Cap tables gather all the important details potential investors would want to know about a startup and make them available at a glance.
A typical cap table is organized according to a standard structure and includes the following important segments.
Stakeholder List
The stakeholder list is a detailed list of all equity holders, from founders to employees that have bought in to outside investors. This list is a crucial component in identifying all parties with a financial stake in the company.
The stakeholder list also breaks down specific data on the types of shares and total number each stakeholder owns.
Equity Ownership Percentages
When breaking down the number and types of shares each stakeholder owns, it’s also vital that the cap table outlines the percentage of the company these shares represent.
To calculate equity ownership percentages, divide the number of shares acquired/purchased by the total number of outstanding shares. The resulting figure represents the shareholder’s percentage of ownership.
Share Classes
The cap table must also outline different classes of shares.
Two primary types of shares generally included:
- Common shares: The majority of the shares available on the market are common shares. Though common shares are paid after preferred stock, they come with voting rights.
- Preferred stock: These shares guarantee a fixed dividend and are paid before common shareholders, but they do not come with voting rights.
Cap tables should also include other, though less common, equity instruments, such as advisor shares, which are shares offered to business partners in exchange for their advice or expertise.
Knowing how the share classes break down is critical information that will keep investors informed and guide the investment decision-making process.
Valuation
The cap table also includes the startup’s valuation, often indicated by the price per share.
When dealing with a startup, the valuation will naturally evolve over time, growing increasingly complex as the startup grows.
Factors that may influence a startup’s valuation include:
- Rounds of funding
- Changes to the employee option pool
- Employees leaving before their options are vested
- Any shares being transferred to other entities
For a startup—particularly one actively pursuing rounds of investments—keeping a cap table current is crucial, as this data is essential to understanding the impact of new investments on ownership stakes.
Generally, a startup begins with a relatively simple cap table, listing only shares held by the founder(s). However, as the company expands—either by allowing employee buy-ins, raising capital through rounds of funding, issuing stock options, etc.—the length and complexity of the cap table will naturally grow.
Since new funding and a broader investment pool leads to the issuance of additional shares and will naturally dilute the ownership percentages of existing shareholders, it’s vital to have access to the most current data at all times to make informed decisions.
Accounting for this dilution is an especially critical consideration for VC fund managers, who need to monitor how their share of the company changes over time.
The Importance of a Cap Table for Venture Capital Funds
The primary purpose of a well-maintained cap table is to ensure transparency among all stakeholders. This transparency is especially crucial for VC fund managers as they assess potential investments, manage their fund’s portfolio, and enjoy assurance that all parties involved are maintaining compliance.
Assessing Potential Investments
VC funds use the cap table to assess potential investments.
Only through getting a clear picture of the current ownership structure and the potential for future dilution can the VC fund managers make the most informed decisions about whether to invest and at what terms.
Managing a VC Fund’s Portfolio
Because VC funds have multiple investments across various startups, they rely on cap tables to inform any decision-making relating to managing the portfolio.
Cap tables give the VC fund access to all the information the need in order to:
- Track ownership stakes
- Evaluate portfolio performance
- Make strategic decisions moving forward
Maintaining Regulatory Compliance
Maintaining regulatory compliance set by the SEC is always important, but these matters become especially crucial during rounds of fundraising, mergers, acquisitions, and early stage investments.
For VC funds, ensuring the compliance of all involved is not just a legal obligation: it is also a way to build and maintain trust with investors through demonstrating responsible management.
How to Create and Maintain a Cap Table
The initial steps in creating a cap table, though time-consuming, are fairly straightforward.
- Identify All Stakeholders. Begin assembling the cap table by listing all equity holders. Start with the founders and, if the startup has reached this stage yet, add early investors and employees with stock options as needed.
- Detail Share Classes. Next, specify the different types of shares issued by the startup and the rights associated with each class (common shares, preferred stock, advisor shares, etc., as detailed above). Be sure to denote who enjoys voting rights and who does not.
- Assign Ownership Percentages. The third step is to calculate and assign ownership percentages based on the total number of shares issued. This calculation is crucial for understanding how much of the company each stakeholder controls.
In most startups, one of the cofounders is generally responsible for the cap table early on, but as the table grows in complexity, management may eventually be taken over by a CFO, another dedicated employee, or a lawyer/law firm.
While there’s always the option to build this document from the ground up using Google Sheets or an XL spreadsheet, specialized software is also available for automated cap table management.
Tools like Carta and Capshare can save time and brainpower, freeing up mental resources to be used elsewhere.
Cap table software tools can also:
- Leverage the powers of automation
- Reduce the potential for errors
- Make it easier to update the cap table as the company evolves
That last point may be the most important because maintaining a clean cap table is absolutely essential.
Only by regularly updating the cap table—especially after significant events like new funding rounds, the issuance of stock options, or the conversion of notes—will VC funds be able to access the information they need for wise equity management.
To that end, startups must build regular reviews of their cap tables into their workflows, taking extra care to double check them in advance of major financial decisions or investor meetings.
This ensures that the cap table remains accurate and reflective of the company’s current state.
The Role of a Cap Table in Fundraising
Because the cap table provides a clear picture of the current ownership structure, venture capitalists and VC funds rely heavily on cap tables when assessing potential investments. Thus a thorough and accurate cap table can positively influence a VC’s decision on how much to invest.
Cap tables reflect how each new round of funding alters the ownership percentages and impacts both current and prospective shareholders, including VCs.
To use some simple and round numbers as an example, if a startup began with two initial co-founders, one of which owned 50,000 shares and the other 40,000 shares, the initial cap table would show them owning 55.56% and 44.44% respectively.
They might then decide to incentivize their employees by offering a round of buy-ins. Let’s say two employees buy in, both at 5,000 shares each. The employees would then own 5% each, with the founders’ ownership percentages dropping to 50% and 40%.
The startup would then use this clear and well-structured cap table as a negotiation tool when seeking initial investors, helping to secure favorable terms.
After each round of investments, the cap table would of necessity be meticulously updated and maintained so as to minimize dilution and ensure that the founders retain control over the company.
The Importance of Professional Help in Managing a Cap Table
Of necessity, cap tables become increasingly complex over time, making them more difficult to manage. Once a startup is dealing with multiple stakeholders, funding rounds, and various financial instruments, there is absolutely no room for uncertainty or iffy numbers.
Fortunately, legal and financial help is available from professionals. Before your VC invests in a startup, these experts can ensure that the cap table complies with all relevant regulations, accurately reflects ownership stakes, and is prepared for any potential legal challenges.
Professional help related to cap table management not only reduces the risk of errors but also provides peace of mind to both founders and investors.
Knowing for sure that a cap table is accurate and up-to-date allows all parties to focus on growing the business rather than worrying about administrative details.
Conclusion
In short, cap tables play a critical role in the success of a startup, particularly in the venture capital space.
It is impossible to overstate the importance of maintaining an accurate and up-to-date cap table in order to manage the ownership stakes within the company. It’s also wise to know when the time has come to seek professional help to manage this complex and essential document.
If you’re interested in launching your own venture capital fund, now is a good time to deepen your understanding of cap tables and consider how you will approach ongoing cap table management.
For more on cap tables, or to access targeted guidance on launching your own venture capital fund, book a call with us today! We look forward to helping you move forward.
