How to Structure a Cap Table for Successful Equity Crowdfunding

Introduction

A cap table (capitilization table) is a detailed statement that shows the shareholders of a company and how much they own. It is an important document that records the financial dynamics of a company’s ownership. A cap table is important when a company needs to be able to quantify equity during a fundraising round or when negotiating a merger or sale.

The purpose of a cap table is to help track ownership, equity, dilution, and conversions of shares of an entity. It is an essential tool when planning an equity crowdfunding campaign, as it can provide a complete picture of the ownership and financial dynamics of a company. A properly structured cap table enables a company to identify vendors, employees, and investors involved in the crowdfunding process. In addition, it helps to monitor the value of the company and track dilution, issuing shares, raising capital, and other financial transactions.

Establishing Equity Valuations

When deciding to pursue equity crowdfunding, it is essential for entrepreneurs to create an accurate Capitalization Table (“cap-table”). Such a table helps track ownership of shares and ensure equity holders (investors, founders, early team members, etc.) are protected and their interests are respected. It is important to have a proper understanding of equity valuations and calculating dilutions in order to design an efficient and successful capital table.

Calculating the Dilution

Equity dilution is the decrease of current shareholder’s percentage of ownership in a company caused by issuing additional shares. It happens when a new investor comes in and takes a piece of the pie, which in turn reduces the percentage of ownership of prior investors. There are two types of dilution: “economic dilution” and “voting dilution”. Economic dilution means that investors and founders’ share of the value of the company is reduced, whereas voting dilution represents the decrease of their voting rights.

A simple equation is used to calculate the dilution. This equation looks at the difference between the total amount of the new stock issued and the previous holders’ stock and calculates a dilution factor. This factor is then applied to the equity of each existing holder by subtracting from their previous equity share.

Finding the Post-Money Valuation

Post-money valuation is a way for companies to measure where their value stands after a new financing round. It is calculated by adding up the equity holders’ value before the money is raised (“pre-money”) and the total amount of money raised in the round. This number should be the same as the company’s market capitalization - the total value of the company.

The post-money valuation of a company is an important metric in order to make sure the company is being professionally valued. It also serves as a benchmark for later rounds of funding and serves to guide negotiations between investors and founders regarding share percentages and dilution.

Determining the Preferred Stock Shares

Preferred shares are a form of equity that provides key financial and legal rights to the stockholder, differentiating them from common stock shares. These shares are more desirable to prospective investors, as they come with additional rights, such as preferred dividends, liquidation rights, and voting rights. As such, it is essential to determine the right share structure in order to gain the confidence of investors and foster a successful equity crowdfunding campaign.

Difference between Preferred and Common Stock Shares

Preferred stock allows certain investors to gain certain rights that are not available to those that invest in common stock shares. Preferred shares usually have a higher priority for financial payments, meaning preferential dividends and increased legal protection for the investor. Common stocks provide greater upside potential, as these stocks are often allocated higher voting rights than preferred shares.

Types of Preferred Shares

Preferred shares come in a variety of forms that provide key rights and privileges to the stockholders. In equity crowdfunding campaigns, there are usually two types of preferred shares that investors can purchase: non-participating and participating. Non-participating preferred shareholders receive a fixed, predetermined dividend and have limited voting rights. Participating preferred shareholders receive a higher fixed dividend rate, and due to their higher stake, may have additional input into the financial and legal decision-making of the company.

• Non-participating Preferred Shares
  • Fixed, predetermined dividend
  • Limited voting rights
  
  
• Participating Preferred Shares
  • Higher fixed dividend rate
  • Additional input into financial and legal decisions
  
  

Issuing Stock Certificates

Issuing stock certificates is a required step when doing an equity crowdfunding raise, as they help demonstrate proof of ownership in the company. Different laws related to the issuance of stock certificates vary by jurisdiction, and the company must ensure compliance with these laws.

Laws Regarding Issuing Stock Certificates

At the federal level, the Securities Act of 1933 includes several provisions related to the issuance of stock certificates. This includes specific language that must be included when issuing stock certificates. Additionally, all entities issuing securities are also subject to state restrictions and requirements, which can vary from state to state. Compliance with laws regarding the issuance of stock certificates is key to avoiding legal issues.

Considerations for Signing Restrictions

When issuing a stock certificate, companies may wish to include signing restrictions. This is done to demonstrate the security of the shares being issued and to ensure the stock cannot be transferred without prior authorization. To this end, there are several specific considerations to be aware of when setting signing restrictions, including:

• A requirement that the certificates must be signed by the company president, CEO, or other corporate officer
• The inclusion of a restricted legend that limits the resale of unregistered securities
• The inclusion of other signatories, such as attorneys or accountants, to ensure the authenticity of the securities

By properly considering signing restrictions, companies can ensure that the equity crowdfunding process goes smoothly and successfully.

Understanding Legal Structuring of a Cap Table

For entrepreneurs, understanding the legal structure of a cap table is a pivotal step to conducting an equity crowdfunding campaign successfully. From applicable corporate laws to different types of securities, entrepreneurs must understand the legal implications of their decisions to comply with the relevant laws before launching a crowdfunding campaign.

Complying with Corporate Laws

Before launching an equity crowdfunding campaign, it’s important to research which corporate laws and regulations are applicable, so that the cap table is structured in compliance with the laws on the books. For businesses with multi-state activities, state corporate laws need to be taken into account. Determine which state law has jurisdiction over the campaign to ensure compliance. Start-up lawyers and professionals should have full understanding of the relevant corporate law and must ensure that the cap table is structured properly.

Different Types of Securities

Another key to understanding the legal structure of a cap table is having a thorough knowledge of different types of securities. Various securities are generally available to investors, such as common and preferred shares, bonds, debentures, and other options. Different securities confer different rights and privileges to investors. As such, entrepreneurs must understand the legal implications of offering different types of securities and must ensure that the rights and privileges of all investors are appropriately represented in the cap table structure.

It is also important to remain aware of federal, state and international securities laws, which differ from region to region. In particular, the United States has a highly regulatory securities environment, which can be complex for entrepreneurs, particularly for those conducting crowdfunds. Compliance becomes even more important if the offering is of the non-exempt variety.

Benefits of Equity Crowdfunding

For entrepreneurs looking to start or further develop their business, equity crowdfunding provides an exciting opportunity to increase their startup capital in order to make their business successful. By giving up equity in their business, entrepreneurs can raise money to fund their project or product, while providing investors with the potential to reap rewards should the business become profitable. This form of crowdfunding carries with it considerable benefits for both parties involved.

Ability to Increase Startup Capital

Most startup businesses require an initial injection of capital in order to be successful. Traditional forms of small business funding, such as bank loans or venture capital, may not always be available and could be difficult to acquire. Equity crowdfunding provides entrepreneurs with the opportunity to raise funds from a larger number of investors in one go, eliminating the need for long and arduous negotiations. This allows entrepreneurs to bypass traditional methods of funding and concentrate their focus on developing their venture.

Benefits to Stakeholders

Not only does equity crowdfunding benefit entrepreneurs, but it also has the potential to provide considerable benefits to the investors who provide the capital. Equity crowdfunding allows investors to take part in an equity deal which would normally be out of their reach, given the average investment amounts are usually much lower than from venture capitalists. Additionally, investors recently introduced to equity crowdfunding have been able to benefit from tax exemptions, offering them an even greater incentive to invest.

• Provides investors with an opportunity to be part of an equity deal which would normally be out of their reach
• Equity crowdfunding eliminates the long and arduous process of negotiating with lenders or other investors
• Some investors can benefit from tax exemptions, offering them an even greater incentive to invest

Conclusion

Equity crowdfunding is an increasingly popular endeavor among entrepreneurs and small business owners seeking to capitalize their ventures. A well-structured cap table is essential for a successful equity crowdfunding round, as it is the blueprint for the investor’s ownership stake in the company.

In this blog post, we covered the fundamentals of creating a successful cap table. First, we discussed the important elements of the cap table. Next, we looked at the different types of equity that may be listed on the table, such as common stock and Preferred A shares. We also outlined the different ways to track ownership in the table, such as using Fully Diluted Capitalization and Fully Diluted Votes.

We then discussed the different options to consider when determining the value of each type of stock, such as using published prices or fair market pricing. Finally, we looked at the different methods and tools to help build the cap table, from manually entering information into Excel, to using third-party software.

Summary of the key points

To sum up, a well-structured cap table is a key component of a successful equity crowdfunding round. When creating the table, you will need to consider the following elements:

• Structure of the cap table, including all forms of equity.
• The method of tracking ownership, such as Fully Diluted Capitalization or Fully Diluted Votes.
• The price of each security, such as published price or fair market pricing.
• The method and tool used to build the cap table, such as manually entering information in Excel or using third-party software.

Final thoughts on the importance of a successful cap table when equity crowdfunding

A successful cap table is essential when it comes to equity crowdfunding. It helps to ensure that all investors are fairly rewarded, based on their equity stake, and that the company’s finances are properly managed and accounted for. By putting in the effort to create a well-structured cap table, you will be better equipped to bring on the right kind of investors and fulfill their expectations.