Instructor for this course

Introduction to Cap Tables

Video Transcript:

"Welcome to the Proformative cap table and corporate stock management webinar. My name is Simon Westbrook, and I am the founder and star performer of Argo, Inc., a financial consulting company that provides the benefits of my experience and knowledge to a number of small companies in the tech field here in the Silicon Valley.

The objective of today's seminar is to provide a background information on cap tables and management of equity structures. We'll be describing what those structures may be. We'll provide you with some thoughts on how you can monitor and measure changes in the equity structures. We'll make you aware of some of the challenges there are in tracking how this cap table will change over the course of time. We'll also look at how this information in the cap table integrates into the financial accounts of the company.

When you think about it, ownership of a company is everybody's dream. Whether you're the founder of the company, or an employee, a member of the stock option plan, ultimately ownership leads to the opportunity of private wealth, so there is a lot at stake in measuring the ownership. That's what the cap table's about, a reliable and accurate way of knowing at any point in time who owns the company, how much, and how they got there.

We will go through a number of areas covering some basic terminology that is used in the world of equity and options. We'll look at the way we set up our tracking structure.

I'm an Excel lover. There are tools out there. There are companies that do provide tools for doing various aspects of the cap table management. Of course, they cost you money, but they're there as the benefit a lot of investment that's been done. My tools, generally speaking, are much more economical at the early stage of development when a company is between startup and, let's say, 10 to 20 million of revenue with hundreds of employees.

We will be looking at the legal basis for the transactions that take place within the cap table bearing in mind that these are both financial and legal issues. We'll be addressing different equity components and how they should be recorded and tracked. Typically, this will include common stock, various classes of preferred stocks, convertible notes, options, and warrants. I will discuss what these are and help you understand them if you don't know the relevance of some of these terms as we go through the agenda.

I'm going to present you the benefit of my personal experience that I have acquired over many years. At my starting point I was using a cap table that I had developed in response to the needs of a company that had about 150 shareholders and had a bit of everything - some common, several Series A stocks with different terms, convertible notes, options, warrants, and so on.

In order to make my experience visible to you in manageable chunks I've extracted portions from my cap table which you'll see in the following slides. Hence the warning at the bottom, these are not a complete Excel spreadsheet. You'll see maybe the totals don't add up. That's because I'm hiding data that you can't see. Just bear in mind this is set up as an example, not as a definitive model.

Basically, I'll start out now, as I said, going through the vocabulary. I apologize for anybody for whom this is too basic, but this course is designed to cover various levels of experience.

Common stock is basically the initial stock that's issued when a company is founded. Generally, this will be subscribed by the founders probably under the terms of a founders' stock purchase agreement. Typically, the common stock is delivered in exchange for payment other than cash. The original founder may well invest $100 or a nominal amount to acquire the stock on the first day when it has no value. It's literally as the paperwork comes out of the box. There is no content in the company at that stage, so the value is very small. The founder may also contribute non-cash components, for example work that he's done, intellectual property that he's created, so there will be forms of consideration other than cash.

As the company moves forward, when real money is required it becomes necessary to bring in outside investors, and they're bringing in real money which gives them sufficient concern to want security. They're going to want preferential rights in a liquidation, and at some stage they will also want the right to convert their preferred stock into common stock to participate in, for example, an IPO or other M and A exit opportunity.

The preferred stocks have value that the common stock does not have. That value is in the liquidation preference. If a company has to be wound up for some reason and there is only a small amount of liquidation value from the assets of the company, that value goes first of all to the preferred creditors who will be the IRS and other people with security, then to the unsecured creditors, then to the preferred stockholders, and finally, if there's anything left, to the common stockholders.

That preference gives the investors at least a better chance of getting some money back in the event of trouble than if they were common shareholders. That gives the preferred share an advantage in terms of its value against the common stock. Typically, there used to be a rule of thumb of ten to one. Basically, that preference should be valued professionally taking into account the expected value of the company and the various preference terms.

The third category that we were talking about is the convertible notes. This is essentially a loan that can be converted into equity. Typically, this may happen where a company is trying to raise money in a hurry and needs to close and get this money early before they've fully completed a round, so they'll issue as a note and convert it when the round is completed.

It's also a hedge device when it's not easy to establish the value of a company. It may be that the convertible note is the security that's given for the money, and the valuation and conversion right does not take place until the company completes the closing of, let's say, a Series A round at a price of $1 a share. At that point the convertible note will convert into the Series A shares.

The next category we'll talk about is stock options. I expect you're probably familiar with these as perhaps employees of companies. An option is the right to buy a share at an agreed price at some future date. In connection with this the company sets up an option pool. That simply means a number of shares that are available to be issued to employees as options.

You'll hear us talk of terms like ISO and NQO. There is preferred tax status to options, and an approved option is known as an incentive stock option. An incentive stock option that fails to qualify under the tax laws becomes a non-qualified option.

Then, you'll hear of vesting which means you don't give the options away at the time of grant, you secure these over a period of employment, typically four years. Most vesting plans provide for 25% vesting after the first year and then monthly thereafter, so if the employee leaves before the end of the vesting period they're only entitled to exercise a rateable proportion of the total grant.

Finally, a term you'll come across more and more these days, unfortunately, is derivative values. I will explain that later, but there is a derivative value in the stock option over and above the price you pay for that option.

Next, we have warrants. Warrants are typically given as a balancing act in another equity transaction. For example, when you're trying to close a Series A round and an investor is looking for a little bit of an advantage they may ask for some additional warrants. It's technically an option but tends not to be granted to employees as are options.

You should also be aware of the concept of primary versus fully diluted shares. You'll probably see this in financial statements as well. The primary shares are the ones that can vote, and have been paid for, and can participate in the ownership of the company today. Fully diluted shares includes those equity instruments which can be converted into primary shares subject to payment, as in the case of exercising an option subject to conversion, as in converting a note or subject to the exercise of a warrant. The fully diluted shares reflects the total maximum number of owners of the company that could take place given the current situation.

Then, finally, we have the term grant or strike price which means the price at which a stock option or a warrant can be exercised by the holder."


Course Syllabus
  13:06Key Tracking Elements
  7:40Common Stock
  6:35Preferred Stock
  11:23Tracking and Conclusion
Continuous Play
  54:59Effective Cap Table Management for GAAP
  PDFCap Tables and Corp. Stock Mgt. Slides
  PDFEffective Cap Table Management Glossary/Index