📄 The Cap Table

🎉 Happy Friday, funds family!

A company’s capitalization table is the “definitive” record of who owns what securities and how much. It’s an important topic for companies and the investors alike, because a poorly managed cap table creates confusion and misunderstandings about ownership, dilution, and economics at subsequent financings and/or liquidation, and in the worst case, can make a company difficult or sometimes (nearly) impossible to fund.

Overall, the cap table should be accurate, up to date, and modeled forward at all times. For companies, that means tracking every share, option, warrant, stock plan, SAFE, and convertible note from day one (the company’s lawyers can do this on their behalf). For investment funds, it means reviewing and diligencing the cap table carefully before every check is written. That is not just to understand current ownership, but to understand the waterfall of economic outcomes at different exit/liquidation scenarios.

➡️ What exactly goes on a cap table?

A fully diluted cap table includes:

•  Common stock (typically held by founders and early employees).

• Preferred stock (typically held by investors in priced rounds).

• Options issued to service providers under the equity incentive plan, whether vested or unvested.

• Unissued options in the option pool (i.e., authorized and reserved but not yet granted).

• Outstanding 📄 SAFEs and/or convertible notes, and the buffer shares they will convert into.

• Warrants to purchase stock, if any.

🔍️ An important term: “fully diluted” means counting all shares on the assumption that all convertibles have converted, all options have been exercised, and all reserved shares exist validly. Investors care about fully diluted ownership because that is what typically gets paid out at exit.

➡️ What is dilution and how does it work?

Dilution occurs whenever new securities are issued. So that means every new financing round, every option grant, and every SAFE or note conversion increases the total fully diluted cap count. That means each existing holder owns a lower percentage of the company. Though if the company is worth more after the round than before, even a smaller percentage of a larger pie can be worth more in absolute terms.

Some common dilution mechanics to understand:

• Pre-money vs. post-money valuation determines how much the new investor is paying and how much dilution the existing holders bear.

• Option pool shuffles, where the option pool is increased as a condition of a new round. That dilutes founders and existing investors but not the new investor, because they usually take effect on a pre-money basis.

• SAFE conversions can be surprising if the company has stacked multiple SAFEs at different caps without modeling the cumulative dilution.

• Weighted-average anti-dilution provisions protect investors in later rounds from down-round dilution (more on that in a future article).

➡️ What tools do companies use to manage the cap table?

The most common platforms are the likes of Carta and Pulley, both of which provide software for tracking equity, modeling scenarios, managing option grants, and generating the reports investors and counsel need at each round.

Using spreadsheets is technically possible, but prone to error, especially as the company grows and the number of convertibles, option grants, and share classes increases. A cap table that cannot be quickly reconciled or modeled forward becomes a liability. We usually recommend that companies use the above platforms once they have raised their first institutional capital.

➡️ What should investors look for and diligence when reviewing the cap table?

Before every investment, an investor should request and review:

• The current fully diluted cap table, showing all share classes, stock plan numbers, and all outstanding convertibles.

• A waterfall analysis showing how proceeds would be distributed at different exit prices.

• A model of the cap table post-closing, including any option pool increases.

• A list of all outstanding SAFEs and convertible notes with conversion mechanics.

• Any side letters that grant special economic or governance rights not reflected on the face of the cap table.

Investors should also ask how the company manages its cap table and whether it is on a platform like Carta or Pulley. A company that cannot produce a clean, fully diluted cap table in response to a diligence request is a concern that should be raised and discussed sooner rather than later.

➡️ The practical takeaway

For the company:

1. Get on a cap table management platform (Carta, Pulley, or equivalent) as reasonably soon as possible and keep it current.

2. Model every SAFE and convertible note in the cap table so that the conversion math at the next round is not a surprise.

3. Build a habit of producing a clean, fully diluted cap table before every financing conversation (that can be done via lawyers).

4. Understand the waterfall: model what the exit looks like for each share class at different prices before agreeing to terms.

For the investor:

1. Request and review the fully diluted cap table before every investment, not just the headline ownership percentages.

2. Run a waterfall analysis at your anticipated exit range to understand what you will actually receive.

3. Ask about all outstanding SAFEs, notes, and side letters. Look for bespoke economics that don’t appear on the face of the cap table.

4. Confirm that the post-closing cap table (including any option pool increase) accurately reflects the deal terms.

Thanks for reading, everyone!

Have a great weekend! 🙌

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This may be considered attorney advertising.