How to Read a Cap Table: Advice for Entrepreneurs

A capitalization table (cap table for short) shows how ownership of the company is distributed among all shareholders. It is the de facto standard entrepreneurs use to show investors what they are buying.

sharks When you are seeking investor money, you are essentially selling something, specifically equity in your company. Providing a cap table when you sell equity in your company is similar to providing a CarFax report to buyers when you sell a used car.

In both cases, you are fully disclosing to the buyers exactly what they are buying. It shows you are honest and reveals (in both cases) material facts that buyers cannot otherwise discern.

Although the cap table is a standard tool among entrepreneurs and investors in private companies, it is not a standard financial statement in a larger corporation.  Learn to read one to be credible to investors.

What Does a Cap Table Show?

A cap table shows in a single table a complete breakdown of the ownership of equity of a company. It displays exactly what classes of stock exist, who owns shares, and how many (and what percentages) of each.

Let’s look at an example where the cap table is being used to show “before” and “after” situations as part of a stock offering. In this case, the stock offering is for 200,000 preferred shares of the company.

Capitalization Table for NewCo, Inc.

 

Before

After

Common

Shares

Undi-luted

Fully Diluted

Shares

Undi-
luted

Fully
Diluted

    George

   250,000

25%

17%

 

   250,000

21%

15%

    Harry

   250,000

25%

17%

 

   250,000

21%

15%

    Sally

   500,000

50%

33%

 

   500,000

42%

29%

Total Common

1,000,000

100%

67%

 

1,000,000

83%

59%

Preferred

 

 

 

 

 

 

 

   Series A Shareholders

        –  

0%

0%

 

   200,000

17%

12%

Total Preferred

        –                               

0%

0%

 

   200,000

17%

12%

Total Common + Preferred

1,000,000

100%

67%

 

1,200,000

100%

71%

Options

 

 

 

 

 

 

 

   Granted

   300,000

 

20%

 

   300,000

 

18%

   Authorized, Not Granted

   200,000

 

13%

 

   200,000

 

12%

Total Options

   500,000

 

33%

 

   500,000

 

29%

Total Fully Diluted Shares

  1,500,000

 

100%

 

 1,700,000

 

100%

Here is a description of the various parts of the cap table shown in the above example:

  • Down the left side, a list of all (classes of) shareholders. In some cases, actual names of shareholders are shown (in the case of the figure, common shareholders’ names are shown). In some cases, they are grouped together as a class (in the case of the figure, preferred shareholders’ names are not shown).
  • Along the top, two groupings of columns are shown; they are labeled Before and After, corresponding to how the company’s ownership looks like before and after the investors make their expected purchase of the 200,000 preferred shares.
  • Along the top, within both Before or After, three columns are displayed:
    • Shares. Number of shares that this shareholder has been issued.
    • Percent undiluted. Percent of total outstanding shares that this shareholder’s shares represent. Thus, if this shareholder owns 250K shares (as is the case of George), and 1M shares are currently outstanding, the percent undiluted is shown as 25% (250,000/1,000,000).
    • Percent (fully) diluted. At this time, a certain number of options have been authorized to be granted to individuals. If all these options were to be granted, and all option holders were to exercise their right to convert those options into shares, additional shares will exist. When we include these shares in the overall count of shares, we call the new count (fully) diluted.

Thus, continuing with the above example, if a pool of 1,000,000 shares have been authorized for options, then George owns 250,000 shares out of a total diluted pool of 1,500,000 shares (i.e., 1,000,000 shares sold plus 500,000 options authorized), then his percent diluted will be 17% (250,000/1,500,000).

Number of Shares

Let’s now compare the Before and After sections. The example above shows the following numbers of shares (see the two columns labeled Shares):

  • The number of founders’ shares is unchanged at 1,000,000. We will almost always see the same number of founders’ shares in every round (unless something unusual happens like a founder sells shares).
  • The number of preferred (Series A) shares increases from zero to 200,000 as we move from before to after. These are the shares that are being sold.
  • The total number of outstanding shares (i.e., total common plus preferred) reflects the same increase, i.e., from 1,000,000 to 1,200,000.
  • The number of options granted and the number of options remaining in the option pool are unchanged at 300,000 and 200,000, respectively.

Undiluted Ownership

It shows the following about undiluted percent ownership (see the two columns labeled Undiluted):

  • Although the number of shares owned by founders (total common) is unchanged, their undiluted percent ownership decreases from 100% to 83% because the total pool of issued shares increased from 1,000,000 to 1,200,000.We will almost always see the percentage ownership of founders decrease with each successive round because the total number of outstanding shares increases. This is because investors generally purchase new shares from the company’s treasury as opposed to purchasing existing shares from current owners.Note that if a founder happens to participate as an investor in a round, those shares are shown on the cap table as owned by the investors in that round, not by the founder.
  • The 200,000 new shares purchased by Series A investors represent 17% of the 1,200,000 total shares.

Fully Diluted Ownership

The cap table shows the following about fully diluted percent ownership (see the two columns labeled Fully Diluted):

  • Once we add 500,000 authorized options to both the before and after totals, the 1,000,000 shares owned by founders represent 67% and 59%, respectively, of the total. Said another way, by selling 200,000 shares to investors, the founders’ ownership stake is diluted by 8%.
  • Once we add 500,000 options to the totals, the 200,000 new shares purchased by Series A represent 12% of the 1,700,000 total fully diluted pool of shares.

A cap table enables investors to understand what they are buying. It enables entrepreneurs to make it clear that they have nothing to hide. In summary, a cap table is an essential tool for communication between entrepreneurs and investors.

Alan DavisThis article is an edited excerpt from the book Will Your New Startup Make Money? by Al Davis. Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.