What is a cap table - and why does your CPA need access to it?
We often get this question from founders who don’t yet have a cap table or are reluctant to give us access to it. When you’re running a company, especially a startup, you may not want many people knowing what the cap table looks like. But you DO need to share it with your CPA!
What is a Cap Table?
A cap table, or capitalization table, is a table (either stored in a spreadsheet or software) that shows the equity ownership capitalization of a startup, including the total value of the shares, total number of shares, the number of shares owned by individual investors, and the percentage of ownership each investors holds. Typically, a startup’s lawyers will manage the cap table using cap table management software such as Carta. Or, for early-stage companies, they may simply use Excel spreadsheets.
What is a Capitalization Table For?
Why a Capitalization Table is Important:
- Defines ownership and equity: Clearly shows the ownership percentage of each person or entity. This helps avoid disputes in case of multiple stakeholders, and clearly shows all parties who owns which and how many shares of stock in your startup.
- Aids decision-making: Determines the voting power of each shareholder for key company decisions. Not only do shareholders get votes on important topics, different classes of shares have specific voting powers at many startups (for example, many preferred shares vote as classes on topics like accepting new investors into the company). The cap table helps lay out all of these ownership stakes clearly so votes can be taken.
- Plans for equity grants: Helps plan future equity distribution to employees or investors.
- Useful for fundraising: Demonstrates company ownership structure to potential investors. A good capitalization table helps founders negotiate with new investors - creating scenarios that show impacts on ownership. Or even planning a fundraising strategy; should you raise now or wait until you have a higher valuation in the future due to your growth.
- Simplifies share issuance: Easily shows the impact of issuing new shares on existing shareholders. Your lawyers will use it extensively at fundraises.
A capitalization table serves as a valuable resource for all stakeholders by providing a clear understanding of ownership and equity, aiding decision-making, planning equity grants, being useful for fundraising, and simplifying share issuance.
How Do You Set Up a Cap Table?
First of all, your lawyers should help with this - they usually will put your startup into a tool like Carta or Pulley, both of which have free plans for small startups that have raised less than $1 million in funding. The steps that they will take are basically going to be:
- Define the Company’s Basics: This includes the number of authorized shares. It’s common for US-based companies to start with 10 million authorized shares of Common Stock, but this can vary.
- Define Founders’ Ownership: Record the number of shares owned by each founder. These are usually issued from the authorized common shares. It’s important to include the vesting schedule for each founder in this step. Founders should carefully record this information prior to getting the table actually set up - you don’t want disagreements.
- Define the Option Pool: Startups generally reserve a section of their available shares to form an Option Pool. This pool is used to issue stock options to employees, advisors, or consultants.
- Record Convertible Notes and SAFEs: If the company has issued convertible notes or SAFEs in fundraising rounds, those will need to be logged and accounted for in the cap table.
- Record Seed Investors and Early VCs: If the startup goes through seed funding or early financing rounds, record this equity issuance from the authorized Preferred Shares.
Remember a cap table should be regularly updated after every transaction involving equity (like fundraising, issuing stock options, converting SAFEs or notes, etc.).
Why your CPA should have Access to your Cap Table
There are a couple of really good reasons to allow your CPA to have access to your cap table.
Your Cap Table needs to be reconciled
By giving your CPA access to your cap table it allows us to review and reconcile it, if need be.
For example: Your CPA will look at the amount of money that each investor should have put into your equity accounts in your financial system, like QuickBooks, to make sure you capture all the money you were supposed to get.
This is for a very good reason, as it isn’t unheard of for wires to bounce or for investors to not actually send the money. This can then leave you short and it would be very embarrassing to figure that out up to a year later. Don’t risk having to go back to the board to admit you didn’t actually get that $250,000 capital. This may sound odd but here at Kruze we’ve seen it happen! We also have a video on this called “Reconciling the Cap Table” so go and check it out to learn more!
Tax agencies need ownership breakdowns
The second crucial reason to allow your CPA access to your cap table is that almost every tax agency needs us, your startup CPA firm, to provide breakdowns of ownership percentages for institutions and for specific shareholders. Especially the founders and large shareholders.
For example: It isn’t just your federal tax return, it can also a state tax requirement. The Delaware franchise tax needs share counts, and even for some municipal filings you will need to be able to provide information on share counts and ownership. So getting access to that cap table is critical for your tax firm.
Real-time access is the best option
It is completely fine to do an export once a year and provide it to your CPA, but providing access to Carta is actually better since it means we can see the changes in real-time.
A typical problem that could arise if you don’t allow access is an out-of-date cap table. For instance, you might export your cap table in October around a fundraise, but then you might make a number of option grants, or someone could leave without being fully vested in December. The October export won’t include those changes so your CPA needs a December 31st year-end cap table in order to complete accurate tax filings.With access to Carta we can look in real-time and see what happened on a certain date.
This leads to another point, which is that it’s smart to review your ownership documentation and records periodically.
When a startup should review its cap table
There are particular moments in the startup journey when a founder - and probably their attorney - should review the startup’s cap table. Some of these key moments are:
- At Founding: This is the pivotal moment when founders agree on equity distribution amongst themselves, marking the first significant use of the cap table to document ownership stakes. As equity is typically apportioned based on each founder’s ownership percentage, it’s crucial to accurately record this distribution in the cap table. Proper documentation helps prevent future disputes, ensuring a clear understanding of equity ownership from the very inception of the company.
- Making First Hires: When you’re about to make your first hires, especially if you’re planning to offer equity as part of the compensation, you need to review your cap table. You should have a clear understanding of your current option pool, and how offering equity to new hires will dilute the shares of current shareholders.
- Before Beginning a Funding Round: Prior to launching a funding round, you should review your startup’s shares and equity to understand the current state of equity ownership in your startup. This can help you determine how much equity you can offer to new investors without overly diluting the shares of existing stakeholders. You’ll also want to understand how much equity you’ll retain after the round. Understanding the potential dilution impacts of a new funding round can also aid in negotiations with potential investors. And you’ll want to make sure you understand the dilution impact that increased option pools will have - read our piece on the option pool shuffle to learn more.
- After Each Funding Round: Each time you receive funding, new shares are typically issued and equity is distributed to investors. Thus, it’s important to update the table to reflect these changes. Have your CPA reconcile the cap table to make sure all the investors’ wires came through!
- Before a Liquidity Event: If a liquidity event like an IPO or direct listing is on the horizon, it should be reviewed and updated so you have a clean document to present to the acquiring company, and so that you can correctly calculate how the proceeds will be distributed.
- Annual Reviews: An annual review is generally a good practice for keeping your ownership list up-to-date and ensuring accuracy. This allows you to catch any potential issues or errors and maintain a clear picture of the company’s equity structure. For companies that have issued options and that haven’t recently fundraised, the annual 409a moment is a good time. Plus, your 409a provider will need this information.
- When Updating Your Hiring Plan: A review of the cap table should be conducted whenever there are significant changes in your hiring plan. For instance, if you decide to hire more staff and intend to offer equity as part of their compensation, you’ll need to understand how these new equity allocations will affect the current ownership structure. A careful review of the cap table will ensure you maintain a balanced and fair equity distribution as your team grows.
- When the Option Pool is Depleting: If you’re aware that your option pool is nearing depletion, it’s essential to review your cap table. This helps you understand the impacts of potential dilution if you decide to expand the pool, or consider other means of equity-based compensation. A review in this situation can inform decisions about how best to continue incentivizing and rewarding your employees while maintaining fair equity distribution.
- Prior to Tax Time: As tax season approaches, it’s crucial to have your equity ownership correctly documented. Both your CPA and tax authorities will need accurate, up-to-date information about your company’s equity distribution for tax calculations and compliance. Ensuring that your ownership calculations and share counts are current and correct can prevent tax-related complications and potential penalties.
Of course, if you are working with good CPAs and attorneys, they will handle the more compliance related tasks for you.
Your startup accountant needs to see your cap table
To summarize, we understand that cap tables can be sensitive but the two main reasons you should give your CPA access are:
- Your accountant needs to reconcile your cap table in order to make sure you collected all the money you are supposed to have collected from your investors.
- Your accountant needs it to accurately fill out tax forms.