What is a Cap Table and Why is it Important?

You are probably aware of the analogy that compares business ownership to pieces of a pie: The ownership of modern small and medium-sized businesses is often divided among investors, founders, employees and management, among other parties. Each of these parties owns a piece of the company’s pie, as the analogy goes.

How can a business owner know how big of a slice each ownership share represents, though? It would be a much different story if a potential investor offered an owner capital in exchange for a sliver of the pie, for instance than for half of it. Business owners need tools at their disposal that describe how big the pie is, name everyone who owns a slice, and explain how much those slices are worth. 

This, in essence, describes the financial document known as a cap table. In this article, we will define the term “cap table,” and then explain in more detail why cap tables are important tools, and how business owners can go about making one for themselves.   

What is a cap table? 

Put simply, a cap table — which is short for “capitalization table” — is a document that comprehensively tracks the ownership of a company. A well-made cap table will list all of a company’s shareholders and security holders, and will track the equity they own in the company. It will include employees, founders, and investors, and will tally things like the stock options, convertible debts, and equity grants they own.

Because cap tables are comprehensive and detailed, they make use of specialized financial terms, including:

• Types of securities. A good cap table will break down the types of securities that each of a company’s equity holders owns. Among others, security types include common, preferred, and restricted stocks, as well as stock options and warrants. 

• Types of shares. In order to present a complete picture of a company’s ownership, a cap table should differentiate between types of owned shares. Outstanding shares, for instance, refer specifically to shares that have been issued, and do not account for non-exercised options; fully diluted shares are the total number of shares that a company would be obliged to grant if owners exercised all available options and warrants. 

• Types of valuations. A valuation is an estimation of worth, and a good cap table will distinguish types of valuations. Pre and post-money valuations, for example, represent a company’s value before and after receiving investment money, respectively. You might also find the term “price per share” in a cap table, which is a number calculated by dividing a company’s post-money valuation by its fully diluted shares. 

How does making a cap table benefit business owners, and why is making one important? 

So, cap tables are a way for companies to track who owns equity in them, and they do so comprehensively, making use of specialized financial terms. Why, though, are they important? Cap tables help small and medium-sized businesses in a few specific ways:

Prepare for and attract investment. One of the most consistent ways for a company to attract investors is by presenting them with rock-solid financial reports. Investors want to know that the money they are risking by investing in a company will be put to good use, and that they will stand to profit from their investment. To this end, accounting professionals like CFOs and controllers 

A cap table is one such document. A well-made cap table will allow business owners to make decisions about how much equity to offer potential investors, and how an investment might impact the ownership of their company. An owner might decide, for instance, that a certain investment isn’t worth a 10% equity stake in their company, based on how many outstanding stock options the company’s management owns, or thanks to a post-money valuation of the company. 

To investors, a cap table is a tool that presents a company’s financiances in a detailed, accurate and professional way. Potential investors will be attracted by a company that takes its finances seriously and tracks its ownership diligently, and a comprehensive cap table will allow them to make better decisions about how much their investment in that company should be worth. 

Prepare for a potential audit. Should a company be facing an audit or other kind of financial investigation, being able to present a well-maintained cap table can be a huge benefit. Investigators will want to know that a company has been conscientious about understanding and documenting its ownership, and a cap table is the essential document which proves this. A cap table that breaks down investments, shareholdings and valuations can help prove that a company hasn’t run afoul of any financial rules or regulations.

Evaluate financial transactions. How can a business owner know if offering a newly recruited employee 1% or 3% of their companies’ shares is a more reasonable offer, or what the outcome of current employees exercising their stock options would be? A cap table helps owners make financial decisions like these, because it can be used to understand what the results of a given transaction would mean for the company’s ownership.

How is a cap table created? 

Now that you understand what a cap table is and why making and upkeeping one is important, you may well be wondering how to make one yourself. At their core, cap tables are just forms of spreadsheets, and there are many free softwares that can help business owners create their own. A cap table can even be created for free, in Excel, if an owner has the knowhow and means to do so. 

There are a few drawbacks to making your own cap table, though. First, as you’ve read above, cap tables can be complex, and they make use of financial jargon; making one, especially for a financial non-expert, would probably mean hours of research and learning. 

Second, cap tables are kinds of living documents, in that you can’t just create one and then forget about it: A good cap table is constantly updated, and requires the collaborative effort of shareholding employees, investors, and business executives, among others. For these reasons, it can be difficult and time consuming to maintain an accurate cap table. 

Third, a cap table is only worth anything if it is indeed accurate. Using Excel or another free software to create a cap table yourself can be daunting, because making a mistake about how much equity a certain shareholder owns would, in essence, ruin the effort. 

Your next step

Most business owners aren’t financial experts, and few have experience in accounting. Accordingly, creating a cap table can seem like a difficult ask for many owners. If you are convinced that an accurate cap table would benefit your business, consider outsourcing an accounting professional to help. Accounting professionals like CFOs and bookkeepers are trained to create and maintain accurate financial documents, and they can help prepare a cap table that best serves your needs. 

How Krieger Analytics can help

So, now that you know how a virtual CFO can help you create an accurate cap table, you might be wondering if you have the means to hire one. And rightfully so: A full-time accounting executive can demand a 6 figure salary, and most small businesses don’t have 40 hours of high-level accounting work to be done every week. Consider, instead, outsourcing the services of a virtual CFO. Even 10 hours worth of consultation with a virtual CFO in a month can mean tangible benefits for your business’ financial health.

Krieger Analytics specializes in outsourcing accounting services for small businesses, from bookkeeping to virtual CFO and controller consultations, and our background in entrapuernship and finance means we know what running a business entails. Our goal is to meet your small business accounting needs without burdening you with the costs of a full-time accounting staff. And, we understand your position as a small business owner, because we have experience running businesses ourselves. 

Have questions about anything discussed in this article, or interested in what valuable insights a  CFO and former franchisor has for your business? Conversations are free, so don’t hesitate to reach out at [email protected], and let us explain how our services could be the right fit for you.