How to Read and Interpret a Cap Table

Introduction

A capitalization table, also known as a Cap Table, is a financial spreadsheet or document used by startups and venture capitalists to keep track of their ownership stakes in a company. It tracks equity, debt, options, and other securities that may be issued. A cap table outlines how much each founder, investor, and employee holds in their equity stake. It is important to understand how to read and interpret a Cap Table for startup founders, investors, and employees in the venture capital landscape.

In this blog post, we'll explore how to read and interpret a Cap Table, the various components of a Cap Table, and the best practices for reviewing and maintaining a Cap Table.

Anatomy of a Cap Table

A cap table, or capitalization table, is a document used to keep track of a company’s ownership structure and provide a snapshot of its equity allocation. An accurately prepared cap table is essential for prospective investors and advisors to identify financial terms and structure the right tailored deal.

The sections of a cap table often vary, depending on the financial situation of the company, but there are some core components that appear in all of them. These components provide an understanding of the company’s current ownership structure and equity allocation.

Overview of Sections and Type of Information Found in Each

The most important sections of a cap table include ownership percentages, securities, valuation and dilution.

• Ownership percentages: This section provides a breakdown of the current ownership of the company, listing out both the number of shares owned and the percentage of overall ownership for each stakeholder.
• Securities: This section details the type of security held by each shareholder, such as common stock, preferred stock, warrants and convertible notes.
• Valuation: This section provides an overview of the total and per share value of the company, as well as its overall level of equity.
• Dilution: This section explains the impact of any new securities issued, allowing investors to see how their investment would be impacted.

Other sections that may appear in a cap table include funding rounds, option pools, debt instruments and conversion notes.

Interpreting a cap table can be complex due to the various factors and scenarios that may be explained. It is important to have a thorough understanding of the document, which is why it is important to use financial services from professionals.

Rights & Privileges

It is critical to note that different investments may provide the investor with different rights and privileges. These can be monetary or non-monetary and should be reviewed carefully when evaluating any given investment.

Equity:

Equity is the most common form of investment for investors and often provides the most rights and privileges. For example, investment in equity often provides the investor with the right to receive dividends, as well as voting rights.

Debt:

Debt investments provide the investor with different rights and privileges than equity investments. The most common example of a debt investment is a loan, which grants the investor the right to receive periodic payments of interest and repayment of the loan principal upon maturity.

Preferred Shares:

Preferred shares are a hybrid security that tend to combine the properties of both equity and debt. Preferred shares often provide investors with the right to receive dividends and/or a fixed payment, as well as certain voting rights. Preferred shares also typically possess a higher priority of repayment than common equity in liquidation.

Convertible Securities:

Convertible securities are hybrid securities that provide investors with the right to convert the security into shares of common stock at a predetermined conversion rate. Conversion can be triggered at the election of either the issuer or the investor.

Dilution & Ownership Structure

Dilution refers to the decrease in ownership percentage of current shareholders when a company takes additional investments. It is important to understand the dilution associated with ownership changes to accurately interpret a cap table. Additionally, understanding the ownership structure of a company can aid in assessing the potential gains and losses of a company.

Calculation of Ownership Percentages

The easiest way to calculate ownership percentages is to divide the number of shares held by a shareholder by the total number of outstanding shares. This can be done for each shareholder. The total of the ownership percentages of all shareholders should equal 100%.

In some cases, a shareholder’s ownership percentage may include more than just the number of shares that were issued. For example, if a shareholder was given options, the number of options granted should be included in the calculation. Additionally, it is important to take into account the vesting periods associated with stock options.

If there are multiple investment rounds, it is important to take into account the different prices associated with each investment round. This is because shareholders who invest later are able to purchase shares at a higher price and may have a higher ownership percentage than an earlier investor.

It is also important to account for potential dilution from possible future raises. Common shares, or preferred shares with multiple classes, can be subject to dilution if additional investments are taken.

5. Valuation of the Company

Understanding the valuation of the company is an essential skill in reading and interpreting a cap table. The will typically value a company before any investments are made. The will differ based on venture type, so it is important to understand the different approaches.

Implications of Difference in Venture Types

The most common types of venture investments are angel investments and venture capital investments. Each type of venture has implications for the valuation of the company.

• Angel Investments: Angel investments are made by wealthy individuals or small groups of individual investors, who plan to hold a stake in the company. These investors may put in anywhere from $10,000 to over $1M at a time. This type of venture may cause the valuation of the company to increase, because of the influx of capital.
• Venture Capital Investments: This type of venture usually involves a professional team of financiers that invest in high-growth technology companies. These investors typically look for a return on their investment. This type of venture may cause the valuation of the company to decrease, because the investors may take portions of the company.

It is important to understand the different types of venture investments, as well as their implications on the valuation of the company, when reading and interpreting a cap table.

Supports Decision Making

As a company grows and its capital structure becomes more complex, a cap table can help inform leadership’s decision making by providing a snapshot of a company’s financial standing. The cap table is an essential part of a company’s strategic decisions, such as pricing its shares or deciding the right type and structure of financing. By having these details on hand, investors and founders can make more informed decisions on a variety of matters.

Examples of how a cap table be used for decision making

When shareholders or founders are considering a new financing round, a cap table can give them a better sense of the magnitude and structure of the financing. By examining the cap table, all stakeholders can more easily visualize the impact of the round on each security and further understand their ownership and control interests.

The cap table can also be used to help evaluate a business’ value before an acquisition. By looking at the cap table, an investor can see how much they would need to invest now to reach a certain level of future control interest. This can inform their decision-making process regarding potential mergers and acquisitions.

The cap table can also be used to monitor a company’s progress over time. Since a cap table records the issuance of securities, outstanding balance, and conversion terms, an investor can track the company’s development by seeing how their ownership or control interests have changed over time.

Conclusion

Understanding how to read and interpret a cap table is essential for entrepreneurs of all stages. The cap table enables entrepreneurs to calculate their ownership percentage, liquidation preferences, and dividend distributions. Furthermore, the cap table provides insight into the relationship between investors and founders; for example, the investor role, individual contributions, and voting rights, which can also have a significant effect on the business.

Analyzing a cap table requires an understanding of the context of the deal and all the legal documents associated. A cap table can provide an understanding of the dynamics between investors, founders, and other related parties. By familiarizing yourself with the contents of a cap table, you can also be prepared to account for any changes by verifying the impact, take corrective action when necessary, and plan for the future.

While understanding a cap table may seem overwhelming at first, understanding the information it contains can be a valuable proactive step for any entrepreneur. Armed with this knowledge, entrepreneurs can confidently explain and assess the situation for investors and other stakeholders. In the end, a comprehensive understanding of a cap table—both structurally and contextually—can be invaluable in aiding entrepreneurs in their own startup journeys.