Very simply, a capitalization table, also known as a “cap table,” shows a stakeholders wise or funding round wise breakdown of a startup’s ownership. A cap table makes it simple to see who owns what in a firm and helps investors understand a startup’s capital structure.
Managing the cap table is an important activity for founders right from the time they incorporatebut it tends to be overlooked. Spreadsheets can become unwieldy when a startup has to track its ownership interests alongside investor stakes and employee stock options.
However, dedicated cap table software automates much of the laborious work, making it simple to issue shares to new investors and manage their equity in the startup over a period of time.
When Does a Startup Need Cap Table Management Software?
Cap table management is critical for precisely managing complications in startup ownership – recording transactions, preparing and signing legal documents, adhering to regulations, communicating with shareholders, being due diligence ready at the time of fundraise, and other such tasks.
A startup’s ability to expand is dependent on the presence of investors who can assist it along the way. A startup would also have a lot of great employees, some of whom may be given stock in the startup.
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When startups do not have outside investors in the early stages, they can typically manage with an Excel spreadsheet. However, as soon as a startup begins the first funding round, it should onboard a cap table software.
Why Does a Startup Need Cap Table Software?
There are numerous reasons why a startup should use cap table software, and the following is a list of the most important ones:
1. Raise funds on better terms
To expand the business, a startup needs to raise funds in several rounds to expand the business. And as it does so, it will have an impact on the ownership and the shareholders’ ownership.
A startup will be able to negotiate terms better if it has a well-managed cap table. Hence, it’s critical to keep the cap table correct and current.
A startup should also be aware that investors will constantly request to see the cap table throughout talks. So, if the cap table is disorganized or if a startup does not have one at all, it will affect the strategy for attracting additional investment. As a result, a startup might find it challenging to raise funds or might not be able to raise funds at all.
Furthermore, the cap table must be set up correctly from the start. It must be accurate and up-to-date. Also read: What are Stock Splits and How Do They Work?
A startup can prevent making costly errors by adequately managing the cap table using cap table software.
2. Issuing options
Another consideration for a company is keeping track of vested shares for all option grants, as stock options typically vest over time. An option holder may leave the company before the expiration date.
Their unvested stock options are subsequently returned to the company. This is because the employee equity plans have a certain amount of time for employees to exercise their options before they are returned.
Hence, the startup must keep track of all the additional repurchases, transfers, restricted stock, and early exercises. Offering equity compensation to employees makes cap table administration much more difficult.
In addition, according to ASC 718 stock expense requirements, all option activity would have to be recorded in the financial statements. And this can be complicated and strenuous for a startup.
So, it is advisable to invest in cap table software to manage all these complications while also updating the cap table to avoid costly mistakes.
3. Staying compliant
Regulation and tax compliance are two other essential aspects of the cap table. For example, if a startup uses a spreadsheet to create a cap table, hours will be spent figuring out what to put in which section of the tax forms.
When it comes to equity compensation, the IRS has several requirements. Any misconduct or violation of the rules can result in severe fines.
Using cap table software will help easily comply with tax and other regulations because the software will notify of any updates. It would also assist in submitting forms, and the startup will no longer have to be concerned about making mistakes.
4. Hiring key employees
Equity compensation is an excellent incentive if a startup wants to hire and keep the best employees. Hence, the startup must understand how to design and implement an excellent compensation package.
Those receiving equity, particularly executives, would want to know their payoff if the startup was acquired at various exit valuations. A startup would need an up-to-date cap table with everything clear.
Many companies are now being far more open with their employees about what their cap tables contain, rather than simply with executives and investors.
This is also why cap table software should be used rather than a simple spreadsheet. It allows employees, investors, and executives to see their holdings at a glance.
Employees would also stay with the company for a more extended time if they saw their options vest and their value improve. It would also serve as a motivator for them to work harder. In short, the startup benefits from growth, and employees benefit from offering and receiving compensation.
The Bottom Line
Even though there is no one-size-fits-all approach to formatting a cap table, it is usually done in Excel spreadsheets at first. However, when the startup grows and offers stock pay, the spreadsheet will become more complex and challenging to keep track of everything. Hence, using cap table software will enable automating and simplifying the operation.
A well-managed cap table can open your doors to hundreds of potential investors that can help you take your business to the next level. trica has the right tool for you if you are looking for a cap table management software that offers all the perks mentioned above and many more additional features.