Key Takeaways
- A capitalization table is a detailed spreadsheet used by startups or early-stage enterprises to show the company’s total capitalization.
- A well-structured and accurate cap table is crucial for both the company and its potential investors.
- Cap tables play a vital role in financial and strategic planning. They help startups track ownership stakes, providing a clear picture of equity dilution after each funding round.
Investing in startups can be a lucrative venture when done correctly. Key to making informed investment decisions is having an understanding of the startup’s capitalization table or “cap table”. This document is the investor’s roadmap, providing crucial details about the company’s ownership structure, value, and equity distribution.
What is a Cap Table?
A capitalization table is a detailed spreadsheet used by startups or early-stage enterprises to show the company’s total capitalization. In simpler terms, a cap table provides a snapshot of who owns what in the company. It includes information on shareholders’ equity, types of equity, and details of all securities such as stocks, warrants, or options.
What are Cap Tables Used For?
Cap tables play a vital role in financial and strategic planning. They help startups track ownership stakes, providing a clear picture of equity dilution after each funding round. For potential investors, a cap table is a vital resource, shedding light on the company’s valuation, equity distribution, and growth prospects.
How to Create a Cap Table
The creation of a cap table starts with listing the company’s securities, beginning with common stock, then preferred stock, and followed by options or warrants if applicable. For each category of security, the cap table should detail the quantity, owners, price per share, and the date of issue. The cap table must be updated regularly to reflect changes in ownership structure after funding rounds, employee stock options, or equity conversions.
What Constitutes a Cap Table? Understanding its Components
A capitalization table, often referred to as a cap table, encapsulates a detailed inventory of who owns what in a company. It’s a meticulously organized ledger that provides a clear picture of the company’s ownership, equity dilution, and other relevant data. Let’s take an in-depth look at the key components found on a cap table.
Shares: The Building Blocks of a Cap Table
At the most fundamental level, shares make up the bedrock of a cap table. They represent ownership units of the company and can be further classified into several categories.
Authorized Shares
These represent the maximum number of shares that a company is legally allowed to issue, as per its articles of incorporation. It’s a ceiling that can only be increased with the approval of the board of directors and, often, the company’s shareholders. Authorized shares serve as an inventory from which a company can issue shares in the future as and when necessary.
Outstanding Shares
Outstanding shares refer to the shares that have been issued by the company and are currently held by all its shareholders. This includes employees who have exercised their stock options, institutional investors, retail shareholders, and founders. The number of outstanding shares changes over time as a company might issue more shares, repurchase existing shares, or have more options exercised.
Unissued Shares
Unissued shares are a part of the authorized shares that have been created but not yet distributed or sold. These shares do not have any voting rights, do not pay dividends, and have no effect on the ownership structure since they have not been put into circulation.
Shares Reserved for Stock Options
These are shares that a company has set aside specifically for issuance under a stock option plan. These plans are often used to attract and retain employees, providing them with a financial incentive tied to the company’s performance. While reserved, these shares aren’t considered outstanding until they have been purchased after an employee opts to exercise their options.
A Dive into Common Equity Types
Various types of equities can be present on a cap table, each carrying its own rights, preferences, and price.
Common Stock
Common stockholders own a portion of the company and have voting rights at shareholder meetings. They stand last in line during asset distribution in the event of a liquidation, meaning they get paid after preferred shareholders and debt holders have been paid. Despite their risk, common shares hold the potential for a significant return if the company does well.
Preferred Stock
Preferred stock is often issued to investors during funding rounds. These shares have a higher claim on the company’s assets and earnings than common stock, often including a fixed dividend, which must be paid before any dividends are paid to common stockholders. Furthermore, in the event of a company’s liquidation, preferred shareholders are paid off before the common shareholders.
Employee Stock Options (ESOs)
Employee Stock Options are often used as a part of an employee compensation package. ESOs give employees the right, but not the obligation, to purchase a certain number of shares in the company at a predetermined price, often referred to as the “strike price,” within a specific time period. They can be a powerful tool to align the interests of the employees with those of the company and its shareholders.
Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs)
RSUs and RSAs are company shares granted to an employee but with strings attached. These shares often come with certain conditions, such as a vesting schedule, which needs to be met before the employee can take full ownership of the shares. These incentives aim to retain talent by offering a lucrative payoff that only materializes if the employee stays with the company for a certain period or achieves certain performance milestones.
Warrants
A warrant is a financial instrument that gives the holder the right to buy a company’s securities at a specific price within a certain time frame. Warrants are often attached to preferred shares or bonds to make these securities more attractive. They work similarly to options but are issued by the company itself, and the proceeds of their exercise go directly to the company, not another investor.
Dissecting Types of Securities in a Cap Table
A cap table also represents different types of securities and their respective valuations.
Pre-money Valuation
The pre-money valuation is the value assigned to a company before it goes public or receives external funding or financing. It is calculated on the basis of the company’s past performance, future prospects, market conditions, and more. This valuation is critical in determining the price per share of new stock issued in the next funding round.
Post-money Valuation
This is the company’s valuation after external financing and capital injections are added to its balance sheet. It equals the pre-money valuation plus the total amount of new capital raised in the latest funding round. This figure is often used by venture capitalists and private equity investors to assess the current worth of the company.
By comprehending these components, investors, founders, and other stakeholders can better understand a company’s ownership structure, value, and equity distribution. Each part of the cap table provides an essential snapshot of the company’s financial health and strategic direction, making it a crucial tool in the world of business and investment.
Importance of a Cap Table
A well-structured and accurate cap table is crucial for both the company and its potential investors. For startups, it’s a tool for managing equity and planning future financing rounds. For investors, it offers insight into the company’s financial health, ownership structure, and valuation. While not all startups are legally required to have a cap table, it is a standard and recommended practice. In terms of access to cap table information, it’s not usually publicly available due to its sensitive nature.
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Alternative Investments and Portfolio Diversification
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments. This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.
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Learn more about the ways Yieldstreet can help diversify and grow portfolios.
In Summary
A cap table is more than just a spreadsheet; it’s a key document that can impact investment decisions and a company’s strategic direction. Understanding how to read and interpret a cap table is a crucial skill for any investor in the startup space.
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2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]