A Founder’s Intro to Equity and Cap Table Management

Learn the basics of equity and cap table management with Travis Rodgers and Chris Hoffmann.

What is a ‘cap table’?

A capitalization table is what shows the details of ownership in a company (who owns what, and how much do they own). Most companies use a software (eg. Carta, Pulley, LTSE Equity, Eqvista) to manage their cap table because they can more easily update and visualize their equity data.

‘Authorized Shares’

Upon incorporation of a new company, the company determines the number of shares they are allowed to issue (this can, and will likely, increase in the future – especially when raising multiple financing rounds). These shares are known as the company’s ‘Authorized Shares’. A common starting point for a company’s number of authorized shares is 10,000,000.

Common types of equity

• Preferred shares
• Common shares
• Restricted stock awards (rsas)
• Options
• Restricted stock units (rsus)
• Safes (simple agreement for future equity)
• Convertible notes
• Warrants

Preferred vs. Common shares
‍
– Preferred Shares
This type of equity is usually sold to investors when raising money for your company. These shares typically come with certain rights and liquidation preferences that make them more favorable for investors.
The preferred price per share that investors pay is what determines your company ‘valuation’ (different from a ‘409a valuation’).

– Common Shares
This type of equity is usually what a company begins with when they incorporate. ‘Founders Shares’ are an example of common shares and ‘Options’ can become common shares.
The price of these shares (the ‘Fair Market Value’ or ‘FMV’) is determined by a ‘409a Valuation’ by a third-party firm.‍

Other Equity Definitions

📄 Restricted Stock Awards (RSAs)
A type of common stock award that vests (is earned) over a period of time.

📄 Options
The right to purchase a set number of shares at a predetermined price (typically determined by the 409a valuation). Options also typically vest over a period of time.

📄 Restricted Stock Units (RSUs)
An award that vests over a period of time and must ‘settle’ prior to the holder receiving company shares (‘settlement’ typically occurs upon IPO/acquisition).

📄 SAFE (Simple Agreement for Future Equity)
A type of IOU/note in which an investor gives money to your company in exchange for future shares.

📄 Convertible Note
 A debt note which can be paid back or converted to equity in the future. These notes typically carry an interest rate.

📄 Warrants
Similar to options, a warrant is the right to purchase shares (can be preferred or common) at a set price. Warrants are oftentimes given to investors who invested in the most recent financing round but want the option to purchase additional shares in the near future.

📄 SAFE Notes
SAFEs are one of the most common ways for companies to raise money, especially when the company is in the very early stages. They are fairly simple, and both investors and companies like them because it can be difficult to determine a valuation when the company is first starting.
SAFE notes provide a way for companies to raise money for operations with the commitment to convert that money into future equity for the investor.

📄 SAFE Notes – Key Terms
Discount Rate – some SAFEs come with a discount rate (eg. 80%) which allows the investor to receive a discount on the price per share of the next financing round.
Valuation Cap – this is a cap (eg. $2m) put on the next financing rounds’ company valuation, so if the new valuation is higher than the SAFE note cap, the investor can get a discount on the price per share at the new round.
SAFE note terms are flexible, so they can include both, either, or none of the above terms. They are negotiated between investor and founder(s).

📄 Equity Incentive Plan (EIP)
Also known as an ‘Option Pool’ or ‘Option Plan’, an EIP is a portion of the cap table that is set aside to give equity to employees, consultants, advisors, board members, etc. A common starting point for an EIP is 10-15% of the company’s total shares.

📄 Vesting
‘Vesting’ refers to the way in which options or shares are earned – the ‘vesting schedule’ outlines the specific way they’re earned. The two most common types of vesting are:
Time-based vesting – earning them over a determined period of time.
Milestone/performance-based vesting – earning them as you hit certain milestones or metrics.
Time-based vesting is most common. Here are some of the most common time-based vesting schedules:
‍
📄 ‘1/48 monthly, 1 year cliff’ (a ‘cliff’ is a time period that must pass before any shares will vest, so in this schedule no shares will vest until one year from the vesting start date).
25% of the shares vest on the one year mark, and the remaining 75% vest monthly in equal installments over the next 3 years.

📄 ‘1/48 monthly, no cliff’
1/48 of the total shares will vest each month for four years.

📄 ‘1/16 quarterly, 1 year cliff’
1/16 of the total shares will vest each quarter for four years.

📄 Types of Options
‍The most common types of options for U.S. based equity holders are:

📄 Incentive Stock Options (ISOs)
ISOs can provide beneficial tax treatment for U.S. employees who follow IRS rules.
ISOs are not taxed when exercised (be aware that they may trigger AMT).
Employees must hold their ISOs at least two years from the issue date and at least one year from their exercise date to have the best tax treatment.
(Additional rules apply to get all the tax benefits).

📄 Non-Qualified Stock Options (NSOs)
NSOs can be issued to employees and non-employees alike (consultants, advisors, board members, etc.).
Holders typically pay tax when they exercise their options. The tax is based on the spread between the price they pay, and the current value of the shares.

📄 ‘Exercising’ Options
This means that you are exercising your right to purchase shares in the company. Simply put, you’re buying shares and becoming an actual owner in the company.
For example, if you receive an option grant for 12,000 options, at $1 per share, and it vests monthly over 4 years, you will vest 250 (12,000/48 months) per month. Each time your options vest, they become eligible to exercise, so you can exercise 250 each month for $250 (excludes applicable taxes). You can also wait to exercise until more options vest.
Remember that exercising is a very personal choice. The value of the company isn’t guaranteed to go up and you’re not guaranteed future liquidity for your shares, so determine for yourself if/when you should exercise your options.

📄 Post-Termination Exercise Period (PTEP)
The PTEP is a period of time in which an equity holder may exercise their options (purchase their shares) after they are terminated from a company. The PTEP is outlined in the EIP document and typically differs between the different termination types. Some typical PTEPs are:
Voluntary: 90 days
Involuntary: 90 days
With cause: 0 days
Retirement/disability/death: 1 year
Some companies offer much long PTEPs (eg. 1, 2, 3, 7 years) in order to help their equity holders have time to pay for their vested shares.‍

Pro Tip

✔ Get your cap table accurate from your company’s inception – you’ll save hundreds or thousands of hours/dollars of future work if you ensure accuracy from the start.

✔ If you plan to raise money from outside investors, I recommend having vesting schedules on all stock and options. Investors prefer to see vesting because it shows that every holder must stay committed to the company to earn their shares/options.

✔ When incorporating, or in the early stages of your company, consider adding ‘Founders Preferred Stock’ as a class of stock. It’s a type of common stock that has some added benefits for founders and early employees (check with your legal counsel) 

✔ If you have an RSA, consider filing an 83(b) form with the IRS within 30 days of the issue date. This will allow you to recognize income and be taxed on the shares on the issue date instead of when the shares vest (if the value goes up in the future, you could save on taxes).

✔ Use a software that has the capabilities to manage and scale with your business as your cap table grows and gets more complex. It can be difficult and very time-consuming for large enterprise companies to move to a different platform when their cap table is large and complex.

✔ Consider allowing options to be ‘early exercisable’. This allows option holders to exercise their options prior to vesting. If they file an 83(b) form with the IRS within 30 days of exercise, they could potentially save on future taxes.

✔ When you are planning to develop an EIP, think about your purpose for creating it. Are you hoping to help employees and give them some skin in the game? Are you looking to add additional write-offs & tax benefits for your company? A mix of reasons? Your purpose with your EIP will determine some of the important details you want to implement in it.

✔ Remember that dilution is ok. If you raise outside funding and your company value goes up while the percentage you own goes down, the overall value of your stock is still going up. The most important thing is to bring on the best investors for your company – the ones that will help you with not only money, but partnerships, connections, opening doors for you, product guidance, and more.

If you need help with your cap table management or anything equity, Equity Admin Co. can help.
‍
*Check out the recorded webinar HERE.
*Download the slide deck HERE.‍