Cap Table Management for Founders

Every year, millions of “startups” are founded around the world. A handful of those will be lucky enough to take on funding, hire talented employees, and eventually go public or get acquired.   

While there are an infinite number of details that go into making this dream a reality, one critical detail is setting up your company’s cap table. Before you do, you’ll want to familiarize yourself with key terms around equity and basic cap table structure.

A cap table is a company’s record of ownership percentages; the cap table changes over time as a result of different financing events and company growth. Historically, the cap table has been tracked in Excel. Today, there are software platforms (like Carta) that can automate the management and compliance checks associated with your cap table. Leveraging software will help ensure accuracy, cut down on maintenance time, minimize expensive legal fees, and ensure you have proper historical data as you grow.

As a startup founder, these are 5 key milestones that will impact your cap table from founding to IPO:

1. Founder’s Stock - The initial names on a company’s cap table are it’s founders. At the outset, the value of founder’s stock is generally close to nothing, but if the value of the company increases quickly founders will need the proper documents in place to ensure tax compliance. If there are co-founders, important conversations on ownership percentages will need to occur to make sure that everyone is in agreement on equity stakes prior to raising capital or hiring employees.
2. Early Investors - Raising capital with early investors will give you the runway you need to start working towards a Series A. Many startups choose to do this via a SAFE Agreement or Convertible Note. Both of these options will eventually convert to stock when the company goes through an equity round. This stock conversion will be a painful process if the cap table is not set-up properly.
3. Employees - Options have become an expected and necessary perk of working for an early stage company. If you want to bring in top-tier talent, but can’t compete with the high salaries offered by more established companies, you can add options to your compensation plan. Once you’ve added employees to your cap table, there are a lot of details that need to be tracked: the number of shares allocated to an employee option pool, vesting schedules, and post-termination exercis e windows, to name several.
4. Compliance - Now that you have the founders, investors, and employees on your cap table, there are reporting requirements you’ll need to make sure you’re compliant with: ​
a. 409a Valuation - This sets the fair market value (FMV) of your company. It’s required by the IRS annually if you’re issuing common shares. The 409a valuation has to be performed by a 3rd party valuation service, and ensures that your options are being issued at a fair value, saving employees from tax penalties.
b. Expense Reporting (or Accounting Standards Codification (ASC) 718) - ASC 718 is an accounting standard for expensing stock-based compensation issued to employees. These reports will become very important when going through due diligence for an M&A or IPO.
c. 10% Shareholder - There are specific requirements around issuing equity to an employee who owns 10% or more of the total voting power across all classes of stock in a company.
d. Rule 701 - This section of the Securities Act of 1933 allows private companies to issue options without complying with federal registration requirements. However, there are specific disclosures if the equity awards exceed $5M in a 12-month period.
e. ISO/NSO Split - You cannot issue more than $100,000 in Incentive Stock Options (ISOs) to any one employee during a calendar year. If you do, the options that exceed the limit need to be issued as Nonstatutory Stock Options (NSOs). ​
5. M&A or IPO - If you’ve made it to the point where you’re considering an M&A transaction or an IPO, the last thing you want standing in your way is inaccurate or missing cap table information. There are strict due diligence processes, involving multiple parties, when preparing for these events. Having clear documentation of your capitalization history will allow you to quickly respond to questions, and ensure these events are seamless.

While proper cap table management and compliance practices are crucial to the financing, hiring, and future of your company, cap table management should never distract you from focusing on your company’s vision. Make sure you have the proper legal, administrative processes, and platforms in place now to help navigate avoidable mistakes and potentially expensive accounting reconciliations in the future.

{Disclaimer: I work for Carta, an ownership management company that automates cap table management and compliance. I am not a legal or financial advisor. I speak with hundreds of early stage companies every month about their equity structures, and how Carta can help maintain accuracy and compliance. This article is based on information I’ve gathered in my time at Carta, and in those conversations. If you’d like to know more, you can schedule a demo of Carta with me here.}

Kelley Oreglia

Kelley Oreglia is a Sales Executive for Carta, a financial technology startup in San Francisco. She is the lead contributor and editor for Ann Kelley (@theannkelley), a lifestyle website for ambitious, civically active millennials. You can follow her on Twitter and Instagram.