Cap Table Management FAQ

A capitalization table (cap table) is a spreadsheet or document that shows the equity ownership structure of a company. It lists all securities issued by the company including common stock, preferred stock, options, warrants, and convertible instruments like SAFEs and convertible notes. The cap table tracks who owns what percentage of the company, at what price they acquired their shares, and under what terms.

Cap tables are critical for multiple reasons: they determine voting rights and control, calculate payouts in an exit scenario, track dilution across funding rounds, ensure compliance with securities laws, and provide transparency to investors during due diligence. An accurate cap table is essential for making informed decisions about fundraising, employee equity grants, and M&A transactions. Errors in cap tables can lead to disputes, failed transactions, and legal liability.

Startups typically have multiple share classes with different rights and preferences:

• Common Stock: Usually held by founders and employees, has basic voting rights (typically one vote per share), and is last in line for proceeds in a liquidation
• Preferred Stock: Typically held by investors and comes with enhanced rights including liquidation preference, anti-dilution protection, dividend rights, and sometimes multiple votes per share
• Series designations (Series A, B, C, etc.): Indicate different funding rounds, each potentially with different terms
• Founders' Stock: Common stock issued to founders at incorporation, usually at a very low price
• Options and RSUs: Granted to employees and represent the right to acquire common stock

Each share class is tracked separately on the cap table because they have different economic and voting rights that affect company governance and exit proceeds distribution.

Dilution occurs when a company issues new shares, reducing existing shareholders' percentage ownership. There are two types: percentage dilution (owning a smaller percentage of the company) and value dilution (your shares being worth less). In venture-backed startups, percentage dilution is normal and expected.

For example, if you own 10% of a company with 1 million shares (100,000 shares), and the company issues 500,000 new shares to investors, you now own 6.67% (100,000 of 1.5 million shares). However, if the financing increases the company's value, your smaller percentage may be worth more in absolute terms.

Common dilution events include: equity financing rounds, employee option pool creation or expansion, convertible note and SAFE conversions, warrant exercises, and stock splits. Anti-dilution provisions in preferred stock protect investors from certain types of dilution, particularly down rounds where shares are sold at a lower price than previous rounds.

A SAFE (Simple Agreement for Future Equity) converts to preferred stock when a qualifying financing event occurs, typically a priced equity round. The conversion mechanics depend on the SAFE's terms:

• Valuation Cap SAFEs: Convert at the lower of the cap or the round's price, protecting investors if the company's valuation exceeds the cap
• Discount SAFEs: Convert at a percentage discount to the round's price (commonly 15-25%)
• Cap and Discount SAFEs: Convert at whichever method gives the investor more shares

Post-money SAFEs (the current Y Combinator standard) specify the valuation cap as the company's value after the SAFE investment, making dilution calculation straightforward. Pre-money SAFEs calculate conversion based on the pre-money valuation, which can lead to more complex cap table modeling.

SAFEs don't convert in M&A events where no equity round occurs; instead, investors typically receive the greater of their investment amount or their pro-rata share based on the cap.

Outstanding shares are the shares actually issued and held by shareholders at a given time, including common stock, preferred stock, and any restricted stock.

Fully diluted shares include all outstanding shares plus all shares that could potentially be issued through conversion or exercise of securities. This includes:

• Unexercised stock options (both vested and unvested)
• Unissued shares in the employee option pool
• Convertible notes and SAFEs (calculated at their conversion price)
• Warrants
• Any other convertible securities

The fully diluted count is critical for calculating ownership percentages because it represents the total potential shares if all convertible instruments converted. Investors typically negotiate ownership percentages on a fully diluted basis.

For example, if a company has 8 million outstanding shares and a 2 million share option pool, the fully diluted count is 10 million. A founder with 4 million shares owns 50% of outstanding shares but only 40% on a fully diluted basis.

Liquidation preference determines how proceeds are distributed to shareholders when a company is sold or liquidated. Preferred stockholders with liquidation preference get paid before common stockholders.

The standard is 1x non-participating preference, meaning investors get their investment amount back first, then can convert to common stock to share in remaining proceeds pro-rata. Participating preferred (less founder-friendly) allows investors to get their investment back AND participate in the remaining proceeds as if converted to common stock. Multiple liquidation preferences (2x, 3x) require the company to return multiples of the investment before common stockholders receive anything.

In a cap table waterfall analysis, you calculate payouts at different exit values to understand when common stockholders receive proceeds. For example, with $10M in 1x non-participating preferred stock and a $15M exit, preferred holders receive $10M, and remaining $5M goes to common stockholders (unless preferred holders convert and take their pro-rata share if that's higher).

Maintaining cap table accuracy requires systematic processes and attention to detail:

• Start with clean records at incorporation, documenting all founder stock issuances with proper board approvals and 83(b) elections
• Record every equity transaction promptly: stock grants, option exercises, transfers, repurchases, and conversions
• Track option pool details including grants, vesting, exercises, forfeitures, and expirations
• When raising funding, work with legal counsel to ensure the cap table reflects negotiated terms
• Reconcile the cap table against legal documents regularly
• Use cap table management software for complex situations

Before any financing or M&A transaction, conduct a cap table audit to identify and resolve discrepancies. Keep records of securities law compliance including Rule 701 limits, state blue sky filings, and Form D filings. Many disputes arise from cap table errors discovered during due diligence.

An option pool (or equity incentive pool) is a block of shares reserved for future employee equity grants. Typically ranging from 10-20% of fully diluted shares, the pool is created to attract and retain talent.

The option pool significantly impacts founder and existing shareholder dilution based on when and how it's structured. Pre-money option pools are created or expanded before new investment is calculated, meaning existing shareholders bear the dilution alone. Post-money pools mean new and existing shareholders share the dilution proportionally.

Investors typically require a pre-money pool sufficient to cover expected hiring for 18-24 months, which can substantially dilute founders. For example, if investors want 20% ownership and require a 15% option pool (pre-money), founders who owned 100% pre-investment would own only 65% post-investment (not 80%).

Unused option pool shares typically get reallocated or canceled at exit. Negotiating the option pool size and whether it's calculated pre-money or post-money significantly impacts founder economics.