The Evolution of a Cap Table- Part I: Founders, Early Staff, and Angels

• A cap table is a record of ownership of a company.
• As new shareholders enter the picture, new shares are issued and the existing shareholders get proportionally diluted.

Equity ownership and growth are what creates exponential returns. In this series of posts, my goal is to unveil how a cap table is built and how it evolves. Understanding and keeping track of its evolution allows assessing the real worth of an investment.

What is a cap table

A capitalization table (aka cap table) is a record of ownership of a company. It is an essential document that illustrates the entire shareholding and what is the involvement of each shareholder — in terms of share and therefore percentage ownership.

Why is it important?

Looking into a cap table is an essential assessment tool for three main reasons:

Calculation of Current Value of Equity Ownership

From the ownership percentage and an assumed valuation, each shareholder can calculate the on-paper value of her shares.

Source of “Red Flags”

From a preliminary analysis of a cap table, a few red flags can already emerge. This might drive more analytical questions that will definitely improve the deal analysis phase.

Scenario Analysis

The cap table enables investors and founders to calculate their ownership value in various business scenarios, thereby assisting them in negotiations around changes to ownership stake should those events unfold.

Basic Dilution

Dilution is the foundational mechanism with which ownership changes hands.

As more shareholders “appear” on the cap table, each shareholder owns relatively less equity — everyone gets diluted equally. Depending on the kind of dilutive event in consideration, as ownership changes hands, the relative ownership stake in a startup is less than it was before. Each time an investor invests (for cash), an advisor joins (for board position) or staff is hired, they all get a slice of the pie. All the slices add up to 100%, always.

The earlier someone joins, or invests in a company, the more they get diluted as they suffer dilution at every event. This means you, the founders of a company and the first owners, are going to take the most dilution.

Simplifying Assumptions

I am going to simplify the cap table calculations by assuming that:

• There are only Common Shares;
• There are no anti-dilution clauses in place — this is a topic that will be discussed later;
• The dilutive event is the issuance of new shares at each round — this means that if a founder gives away a percentage of his company, the numbers of total share are adjusted to make sure the new percent ownership matches;

We will then tweak the assumption to see how the model changes as we add complexities into the model. I will start by considering the basic case in which we start from two founders, add some early staff and then a single angel investor.

Equity at Company Formation

We will start from a situation where there are two founders owning 100% of the Common Shares of the company. This usually happens at company formation and it is the starting point.

Equity Issued to First Employees

Founder start the hustle but soon there is a real necessity to get new talents on board. New operators are added and founders decide that the early staff portion is worth about 10% of the company.

Typically founders will give 5–10% of the company to early staff. This can be done in options (we will discuss it later) but in this case, they are opting for “founders stock”, i.e. common shares that are the same as the one the founders own.

A new issue of share is agreed and now the two founders are diluted 10% and the new entrants own 10% of the company. Numerically it will look like this:

About 111,000 shares are issued and assigned to the early staff: the founders now own 90% of the company.

Seed and Angel Round

The operation is growing bigger and it seems time to involve some early-stage investors to accelerate growth. This happens by involving a Seed VC firm or one or more angel investors.

Typically, seed investors require between 10% and 25% of equity to invest. Let’s assume that one angel investor wants to get involved for 10% of the company.

Again, a new issue of share is agreed and now the two founders and the early staff are diluted by 10%: the two founders will end up owning 81% of the company (i.e. 90% minus 10%) and the early staff 9% (i.e. 10% minus 10%). The new entrant owns 10% of the company.

The next steps involve creating ESOP (Employee Share Ownership Plan) and considering Series A and B investments.