Startup Cap Tables and Valuation: What to Know

By Lisa Bowersox

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A capitalization table, or cap table, is a critical tool for any company. New and early-stage businesses in particular rely heavily on cap tables for valuation. However, creating and maintaining cap tables can be particularly overwhelming due to the intricacies and financial terminology involved in providing a comprehensive analysis of a company’s shareholders’ equity. Even if your startup cap table is up, running, and being actively managed, you may not understand exactly how it works or how it can be leveraged for business valuation. This article explains the basics of startup cap tables and their role in the business valuation process.

What Is a Startup Cap Table?

A startup capitalization table is a record, often a spreadsheet, showing a new or early-stage business’ equity capitalization. Some startups choose to build and manage their own cap tables using software or a cap table template. However, many startups find that working with a company that provides cap table management services makes the process smoother and more precise.

We Believe It Matters 

As a startup, you will be constantly making decisions that are influenced by and/or will affect your capitalization. An accurate and well-organized startup cap table empowers you to make good decisions quickly.

What’s Included in a Typical Startup Cap Table?

A cap tables can be as simple or as complex as your business needs, but a typical startup cap table include the following information:

  • Names of founders, investors, common stockholders, etc.
  • The quantities and types of securities they own
  • The value of those securities
  • When they invested
  • What percentage of the company they own

Typical Startup Cap Table Example

Source: Cooley GO

Cap Table Terms to Know

  • Common stock – Also referred to as a common share, a common stock is a security that represents ownership in a company. This standard stock is typically the type of security that startup founders and employees receive.
  • Preferred stock – Also referred to as a preferred share, a preferred stock is similar to a common stock, but it includes some added protections for shareholders. This makes it a lower risk investment.
  • Stock option – An option gives an investor the right to buy or sell a stock at an agreed upon price and date without any actual obligation.
  • Convertible note – This form of short-term debt converts into equity, usually after a future round of financing. Instead of a return in the form of principal plus interest, the investor loaning money would receive equity in the startup.
  • Outstanding shares – Any authorized shares held by or sold to a company’s shareholders, exclusive of treasury stock held by the company itself, are known as outstanding shares.
  • Fully diluted shares – These are the total common stocks or shares of a company including currently issued or outstanding shares as well as shares that could be claimed by converting preferred stock or exercising outstanding options and warrants.
  • Pre-money valuation – Pre-money valuation is best described as how much a startup might be worth before it begins to receive any investments into the company.
  • Post-money valuation – Thus, post-money valuation is the value of a business after an investment round.

However, cap tables are more than just spreadsheets. When raising VC, startup cap tables can be used to model how different valuations will affect potential payout.

Assessing Your Valuation Team

An idea held by some advisors in many dominant startup cities (Silicon Valley, NY, Austin) is that Common Stock (ASC 718/IRS Section 409A) and Investor Preferred Stock (FASB ASC 820) valuations are pointless formalities: the cheapest path to compliance is the best way to go. Why is this the case?

One can see how some advisors, even venture capitalists, might counsel startup clients to go that route. However, by working with clients and using their cap table management products—to the extent that the data is correctly entered, the platform removes the headache of maintaining accurate records of shares and options outstanding. Cap table management companies often help those clients navigate strategies and utilize platforms to sell securities and process tender offers to redeem employee shares. This type of service may be increasingly useful as Reg D/Crowdfunding options emerge.

However, there is a problem. A “gift with purchase” valuation work product doesn’t guarantee the depth or breadth of a professional, white-glove work product. An inferior valuation can come back to bite the startups that ultimately become successful. Perhaps advisors counseling young companies to comply at the lowest possible cost decide to play a numbers game. In their view, so few of these companies will become later stage companies that it doesn’t really matter. 

Why Quality Valuation Matters

When you are successful, there will be scrutiny of your board’s prior corporate actions to set stock valuations and issue options. If the valuations that support corporate decision making don’t hold up under review by an auditor or an acquirer’s due diligence team, some difficult and expensive clean-up work will be required.

High-quality valuations require custom and bespoke modeling for each company beyond what an algorithm can provide. The SEC and IRS don’t seem to have much interest in easing the compliance standards for private security valuations, whereas the primary appraisal credentialing organizations (ASA and AICPA) have valuation credentials that require minimum performance standards. These are essential for any startup to consider.

How to Choose a Business Valuation Firm

Founders and their teams should know who the analysts conducting their valuation are, their levels of experience, and how they appraise your company. For instance, you will want to ask if valuation analysts will communicate directly with you or rely solely on black-box methods to calculate values. Young companies deserve a valuation team that understands the report output they produce and are confident it goes beyond basic elements.

Some valuation advisors may counsel startups that all early stage startups are the same. In a world where you hear that projections are just estimates anyway, this may sound appealing. But it just isn’t true. Valuations should be completed under the assumption that early stage startups become successful later stage companies, and the early valuation work needs to connect to the later valuation work. If this isn’t the case, things go off the rails.

Not all early stage companies are the same. And it is for certain that there is HUGE diversity in the types of companies issuing stock-based compensation. Young startups coast to coast need to carefully consider compliance issues.

Company leadership should be aware of “good enough” approaches. Any business valuation firm under your consideration should follow rigorous appraisal standards, and in many cases, work with the national and regional accounting firms to take the standards and generally accepted practices further than the guidance requires. Informed judgment is required to go beyond just guidance. 

In addition, any business valuation firm must be able to support its work, from the first draft through the audit and on to the tax court, if necessary. 

Much More Than “Good Enough”

Venture First has a strong philosophy about what a “good enough” valuation means: good enough doesn’t exist. Only the highest quality valuation will suffice. At the same time, we are in constant pursuit of maximum efficiency. This allows us to offer our business valuation services at a fair price, but never at the expense of quality.

As startup leaders assess the factors surrounding a 409A or ASC820 valuation, we’re here to help. Contact us today for one-on-one advice about this critical step in early stage growth.

Originally published September 2017. Updated July 2021.

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