Cap Tables

from Formation to Exit

Contents
Introduction........................................................................3 Series A................................................................................16
Term Sheet.................................................................................... 16
Company Formation...........................................................4
Converting the Note.................................................................... 16
Shares and Share Capital.......................................................... 4
Convertible Note Shuffle............................................................ 17
Share Classes and Share Rights.............................................. 4
• The Investor Friendly Approach...................................... 17
Articles of Association and Memorandum of Association.. 5
• The Founder Friendly Approach...................................... 17
Primary Transactions: Issuing Shares.................................... 5
Series A Negotiations................................................................. 18
The Company’s First Cap Table................................................ 5
Series B-G..................................................................................... 19
Seed Round.........................................................................7
The Exit................................................................................21
Valuation Pre-Money and Post-Money.................................... 7
M&A................................................................................................. 21
Option Pool Shuffle..................................................................... 8
IPO.................................................................................................. 21
• The Founder Friendly Approach...................................... 9
A Likely (and Simplified) Exit Scenario.................................... 22
• The Investor Friendly Approach...................................... 9
The Company’s Second Cap Table.......................................... 9 Summary.............................................................................23
Employee Equity Remuneration.......................................10
Stock Options, Warrants and Phantom Shares.................... 10
• Stock Options..................................................................... 10
• Warrants.............................................................................. 11
• Phantom Shares................................................................ 11
Equity and Cash Split.................................................................. 12

Convertible Note.................................................................13
Standard Convertible Notes...................................................... 13
SAFE Note..................................................................................... 13
Advanced Subscription Agreement......................................... 14
When to Use a Convertible Note............................................... 14
The Company’s Fourth Cap Table............................................ 15
The Cap Table – From Company Formation to Exit The Cap Table – From Company Formation to Exit

Introduction
A recurring topic of conversation we have here at Capdesk
is, unsurprisingly, that there’s a need for companies to be
more knowledgeable about the capitalization table, also
known as a ‘cap table’. We see ‘broken’ cap tables all the
time and, more often than not, companies make mistakes in
their shareholder registers or employee share plans because
of that. These mistakes can sometimes cost businesses
millions of pounds. And, for the record, if you’re curious
about what kinds of cap table management errors we see in
the hundreds of companies we help, you can read all about
it here.

Oftentimes, it can be difficult to fully grasp the severity of

consequences we have not personally experienced. That’s
why, unfortunately, many businesses don’t understand
just how important it is to pay huge attention to details of
ownership until they reach a crucial stage in their journey
(such as an acquisition), by which point it’s too late to prevent
the chaos resulting from mistakes in equity reports. The cap
table is the cornerstone of all equity reports and filings, as
well as an important part of any company throughout its life
- from formation to exit. It’s the database in which rights to
the company’s value are listed and, as we will illustrate over
the next few chapters, it’s not always easy to understand how
cap table decisions affect the company stakeholders. In our
exploration of the topic, we will mainly focus on understanding
cap tables for UK companies, but some references will be
made to European norms in general.

3 3
The Cap Table – From Company Formation to Exit

Company
Formation
The first time that a founder will have to make decisions
which will affect the company cap table is when forming
Shares and Share Capital Share Classes and Share Rights
the company. In most jurisdictions, a company entity is First, the founder has to decide how many shareholders
necessary for the founder to provide services without When decisions have been made regarding the number of
will be involved in the business. If the company expects
personal liability and to operate with VAT. To form the shares and capital investment, it’s time to consider share
to receive investment at a later stage, it should consider
company, the founder has to make several decisions classes (i.e. types of shares) and the share rights that
issuing plenty of shares already from its formation. This
regarding the company’s shares and share capital, as well as come with each of these. From a legislative perspective,
can solve the need for corporate actions (and the admin
produce articles of association. there are no limitations to the number of shares or share
work that comes with it) later on, such as doing a share
classes a company can issue, but best practice is to keep
split, whereby existing shares are multiplied and share
things simple and incorporate the company with a single
certificates re-issued.
share class. The company can soon enough have a need
The number of shares issues per shareholder, as well as the for more share classes, especially if the strategy is to build
Further reading on company formation:
individual share’s nominal value, will vary from business the company with venture capital investment. For example,
Crunch gives a summary of reasons why to
to business. Note that shares are issued against capital a venture capitalist (VC) will often insist on a new class of
start a limited company in the UK.
investment, which means the founding partners will have shares with specific rights when investing (which we will
to invest an amount corresponding to the number of get back to in chapter Series A negotiations), so it’s smart
shares multiplied with the nominal share price. In the UK, to start with as few classes as possible to avoid your equity
shares can be issued at a nominal value of 0.000001 (six structure becoming overly complicated down the road.
decimals), so a company can be founded with 1,000,000 Indeed, most companies will incorporate with a single
shares against a capital investment of £1. class of shares, called ‘ordinary shares’ (the name can be
changed later if there is a need for it). An ordinary share will
The £1 capital requirement in the UK is quite generous to assign shareholder voting rights and dividend rights, also
entrepreneurs. In countries where capital requirements known as share rights. Voting rights means the right to vote
are higher than £1, it’s worth to remember that the capital at the company’s general assembly, and can be assigned
invested in the company formation will be recorded on the with any multiple. Some ordinary shares can have one
balance sheet and can be used in the company’s operations. vote, while others may have 10. Dividend rights mean the
shareholders right to participate in the company’s profits.

4
 The Cap Table – From Company Formation to Exit

Articles of Association and provided by the company) and return it along with the
relevant payment for the shares they wish to buy.
two months after its board resolution meeting. The register
of allotments must also be updated to reflect the details
Memorandum of Association The company must then host a board meeting, where all
of each individual share issuance - in other words, even
if shares are issued to an existing shareholder within the
In the UK, the thoughts and decisions regarding the number potential shareholders’ applications are reviewed, and
company, the business still needs to update its register of
of shares and share rights should result in two documents a decision is made about what shares will actually be
allotments to illustrate the new shares this person received.
necessary for formalising the company formation - the allotted and to whom. The meeting’s final decisions must
articles of association and a memorandum of association. be formally reported in a document called ‘board resolution’. As a side note: even though the company doesn’t need to
The exact contents of this may vary, but as a minimum worry about this right away, it will ultimately have to provide
A company’s articles of association constitute a document
it should outline the number and nature of shares issued the details of its new shareholders when filing its Annual
defining its purpose and regulating its operations. Share
and to whom, specify the forms that need to be submitted Confirmation Statement (i.e. CS01) to Companies House. To
classes, share rights, and share capital are defined in
to Companies House following the issuance, authorise the read more on how to file a confirmation statement, take a
the company’s articles of association as all have an
issuance of share certificates to the new shareholders, look at our relevant guide .
effect on how different tasks are to be performed within
and highlight the updates that need to be made to the
the organization.
company’s register of members and register of allotments. The Company’s First Cap Table
A memorandum of association gives an account of the
Following that, a business in the UK will have to issue share In the following example, we’ll form a company with two
subscribers participating in the company’s formation.
certificates to its new shareholders. This should be done as equal co-founders. Each will receive 100,000 ordinary
More specifically, the document includes the name of the
soon as possible, and no later than two months after the shares on a nominal value of £0.01 in exchange for an
company, the name of its subscribers, as well as each
share allotment, because a share application usually only investment of £1000. The company will now have two
subscriber’s signature.
becomes binding once the applicant becomes notified that shareholders, 200,000 shares outstanding (i.e. the total
Once these documents are formalised, the company can his or her application was accepted. Therefore, in theory, equity held by the stakeholders), and a share capital
officially be formed and start issuing shares. the company could end up issuing shares and have the of £2000.
applicant withdraw their application shortly after, creating a
Primary Transactions: bureaucratic headache for management. Shareholder Ordinary shares % Ownership £ Value

Founder I 100,000 50% £1000

Issuing Shares The next step is filing an SH01 to Companies House, to notify
Founder II 100,000 50% £1000
them about the company’s current capital structure and
A share issuance, (often used interchangeably with the term any amounts that have potentially not been paid on them.
‘share allotment’), is a common way for businesses to raise Finally, the register of members and register of allotments
funds or otherwise benefit the business (e.g. offer them as will have to be updated to reflect all new share issuances.
an incentive to recruit key employees). To issue shares to a Technically, new shareholders are officially recognised
new shareholder, the first step is to simply offer them to that as such when they’ve been added to the company’s
person verbally or, more formally, in writing. The recipient shareholder register. Note that, in the UK, the company is
must then fill out an application for new shares (normally legally obliged to register its new shareholders no later than

5
The Cap Table – From Company Formation to Exit

figure 1 - The share issuance process

Make
Make offer
offer to
to Hold Board Meeting
potential shareholder
potential shareholder (Board Resolution)

1 22

Issue Share Certificates

for Shareholders

File SH01 to File an Annual CS01 to

Companies House Companies House

4 5

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 The Cap Table – From Company Formation to Exit

Seed Round
The term ‘seed round’ is used to indicate an early A seed round investment is usually considered to be a business. A company with high capital requirements
investment in a startup company which is made before the high risk investment. Due to this high risk, investors in should generally be valued higher, in order to account for
company has any revenue and often before there’s even a seed companies are often private individuals with good further dilution before reaching profitability. In the following
product available. knowledge of the founding team or by industry experts with example, we’ll use a £1 million investment into the company
good domain knowledge. Such individuals are commonly at a £4 million pre-money valuation. Deals like this are
known as business angels or angel investors. usually agreed on a pre-money basis. Pre-money means
the valuation of the company before any new cash has
Not every company will need equity investment from an been invested. Post-money means the valuation after the
external investor, but it’s very common in businesses with money has been invested. It is important that the parties
high start-up costs, long route to first revenue, and few are aligned and explicitly agree on the valuation. As this
tangible assets (such as manufacturing tools) which can be example shows, the difference between pre and post-money
used as leverage in loan financing. is quite severe for both parties:

The company’s cap table will be affected by the seed round Investment Dilution % - percentage
when new shareholders or debt holders are investing in the
£1M at £4M pre-money 20%
company and is central of deal preparation, negotiation
and valuations. £1M at £4M post-money 25%

The valuation discussion is important to the founders

Valuation Pre-Money and whose initial £2000 investment now has a paper value
Post-Money of £4,000,000. That’s a great return after a couple of
months working on a good idea. It’s therefore crucial to
Valuations can be tricky, especially in the early days of a consider “paper value” - the shares are worth nothing before
company’s life where there are few or no tangible assets. materialisation. As we shall see in the following paragraphs,
At this stage, a valuation is more art than science and the initial share value registered on the cap table will go
it’s the result of negotiations between the investing and through numerous stages and changes before the company
issuing parties. Parameters to consider when setting reaches an exit.
a company valuation is the valuation of comparable
companies and the future capital requirements of the

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The Cap Table – From Company Formation to Exit

Option Pool Shuffle The Investor Friendly approach, which is also called a
‘pre-money pool’, gives the investors a greater share of the
The Founder Friendly approach, also known as a ‘post-
money pool’, is the opposite way of issuing shares to
When negotiating their seed funding, companies often company. In this approach, employee share options are investors and ultimately gives them a smaller share of
face the challenge of forming a solid strategy to attract allocated first, and then the investor is allocated his or her the company. The investor is allotted shares first, and the
new talent that will contribute to building and scaling the shares. As a result, the investor share allocation dilutes option pool is created subsequently. The effect of this is
business. In a company’s early days, it is often impossible the share option pool, and therefore the VC ends up with a that the investor’s shares are diluted by the new pool and
to compete with established businesses based on salary, greater percentage of the company. he or she therefore ends up with a smaller percentage of
so founders have to approach recruiting in other ways. For the company.
example, they can offer attractive working lifestyles, flexible
working hours, better company culture, or promise share
options and thereby give employees the opportunity to Figure 2 - Creating a pool pre- and post-money
participate in the company’s value. At this stage, a company
will typically issue 10%-15% of its total share capital to the
option pool - also referred to as an ‘equity pool’ to denote
the inclusion of other equities, such as warrants.

The option pool shuffle relates to a question of how many Pre-money shares are allocated to pool and
investor simultaneously. Only existing
shares will be ultimately allocated to investors when the Pool shareholders are diluted.
company also creates an option pool to reserve shares for
employees. In terms of the above, there are two different
approaches to creating an option pool: the Investor Friendly
Approach and the Founder Friendly Approach.

Allocate shares to
Post-money option pool.
Allocates shares to
Pool investor. existing
Existing shareholders
shareholders are
and new investor are
diluted.
both diluted.

Existing share capital

New option pool allocations
New share capital issued

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 The Cap Table – From Company Formation to Exit

In the following section, we will illustrate the difference In this scenario, the company will issue shares to the option As the comparison between the two approaches reveals, the
between the two approaches. In our example, before pool and then to the investor. To calculate the allocations, option pool has a significant effect on the founder’s share
receiving its £1 million investment the company’s total we first have to set a share price for the round. The price is value which has dropped from £4,000,000 in the founder
number of shares is 200,000 with a pre-money valuation calcula ted as pre-money valuation / (shares outstanding friendly scenario to £3,500,0000 in the investor-friendly
of £4 million. The option pool will be 10%. + options). Since the option pool allocation and the investor scenario. Further, while the investors share value remains
allocation are both linked to the post-money total number of the same in the two scenarios, the number of shares
The Founder Friendly Approach shares, we’ll have to make assumptions so that the option allotted increase by 7,142 shares. This difference will have a
pool becomes 10% or close to post-funding. In this example, significant effect on the investor’s position later on.
Allocating shares based on a founder-friendly approach, the the assumptions lead us to a share division of:
company is issuing shares to the investor before creating
the employee option pool. To find the number of shares Shareholder Ordinary shares % Ownership
The Company’s Second
issued to the investor, we have to first find the share price:
Founders 200,000 70% Cap Table
Pre-money valuation £4,000,000 / Shares outstanding
Seed Investor 57,142 20%
200,000 = £20.00 per share. The number of shares can Following the seed round, the company will issue new
now be determined, by dividing the investment amount Option Pool 28,152 10% shares and update the cap table. The option pool will be
£1,000,000 by the share price of £20.00 = 50,000 shares. Total 285,644 100% included in the cap table’s fully diluted ownership, but will
Creating the option pool following the allocation will then not have the right to exit proceeds before the option is in the
result in 27,778 shares (10% of 277,778 shares the new total We can use the allocation to calculate the share price: Share hands of an option holder with the right to exercise. So until
number of shares) and dilute the investor’s position to 18% price = pre-money valuation of £4,000,000 / (issued shares the company starts granting options, all capital proceeds
ownership (50,000 / 277,778 = 18%). 200,000 + option pool shares 28,152) = £17.500033 will be shared between the founders and its investor.

Shareholder Ordinary shares Ownership-% £ Value The price per share can be used to compute the investor’s Shareholder Ordinary shares % Ownership £ Value
real investment size based on £17.500033 * 57,142 shares =
Founder I 100,000 36% £2,000,000 Founders 200,000 70% £3,500,007
£999,987 investment.
Founder II 100,000 36% £2,000,000 Seed Investor 57,142 20% £999,987
Seed Investor 50,000 18% £1,000,000 Shareholder Ordinary shares Ownership-% £ Value Option Pool 28,152 10% £499,993
Option Pool 27,778 10% £555,560
Founders 200,000 70% £3,500,007 Total 285,644 100% £4,999,987
Total 277,778 100% £5,555,560
Seed Investor 57,142 20% £999,987

The Investor Friendly Approach Option Pool 28,571 10% £499,993

Total 285,713 100% £4,999,987

An experienced investor will most likely ask the founders to
take an investor-friendly approach and issue shares to the
option pool before investors so that the option pool will total
10% post-money.

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The Cap Table – From Company Formation to Exit

Employee Equity
Remuneration
After concluding the funding round, our example company
has enough cash to start recruiting employees to help
Stock Options, Warrants and Unlike shares, options aren’t taxed until they are exercised,
so long as they were issued at or above the fair market
build the business. It has even made the option pool as Phantom Shares value of the underlying shares. Options, though not actually
requested by the seed investor, and will actively be using shares, are typically counted as part of the “fully diluted”
options to align the team and mitigate some of the salary Stock Options shares of a company.
competition. But, what kind of securities should it be
issuing and how many? There is a number of securities A stock option, or share option, is a contract that gives the Companies establish share option programs as part of an
that could be considered here, but in this chapter we’ll be recipient (usually an employee) the right to purchase shares overall employee compensation plan for several key reasons
looking closer into stock options, warrants, and phantom in the company at a specified price (also known as the Notably:
shares in particular. “strike price”) by a specific date. The employee is under no
obligation to buy, or “exercise”, any or all of his or her options. 1. Option programs can boost employee morale and help
Typically, but not always, options will “vest” over time. In attract talented, high-skilled workers who are motivated
other words, the employee will not be able to exercise his to help the company improve and succeed.
or her options straight away, but will have to wait until a
specific point in time whereby some or all of the options 2. Employees holding options to purchase shares feel
have vested - i.e. have become exercisable. If an employee more like owners or partners in the business and are
leaves the company or is fired, they typically have 90 days invested in the company’s success.
to exercise their unexercised options that have vested or
3. In addition to being a benefit for employees, share
they implicitly forfeit them. Employees will typically forfeit
option plans are cost-effective for companies with the
any unvested options.
only significant costs to the company being the lost
opportunities to sell some shares at market value in the
future and the expense of administering the plan.

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 The Cap Table – From Company Formation to Exit

Options are a key currency in early stage companies, who Warrants

often make a bargain with staff of below-market/lower cash
compensation in exchange for a share of the company’s A warrant is similar to options - i.e. contractual rights for
future success. It’s a critical incentive to attract talent while investors or other third parties to buy stock in the company
the company is still cash poor. at an agreed price within a set timeframe. However, it
differs from options in that it’s not issued through the
company’s option pool. Nevertheless, the board still has
Figure 3 - The share issuance process to approve allotment of warrants. In some jurisdictions -
mainly continental Europe - warrants are often preferred
Vesting Period over options as a security for employee remuneration, due
The period between the grant issuance and when the grantee’s to tax considerations. In early-stage deals, companies
options are fully vested. After the cliff, options often vest in
equal monthly or yearly tranches. Eg. a schedule could vest 75 can offer warrants as an incentive for investors to invest
options after a cliff of 12 months and then vest 10 options a sooner rather than later, given that warrants allow investors
month for the next 36 months.
the opportunity to ‘top up’ their initial investment at the
same price in the future, thereby reducing the risk of
that investment. This practice is often combined with
the issuance of convertible notes. The combination is
Cliff % particularly attractive to investors because warrants
Describes how large
a portion of the total represent an upside appreciation without any capital
grant forms the commitment, while convertible notes are a loan that often
cliff. Eg. if the total
grant size id 240 carries interest. As a result, investors are protected as debt
options and the cliff holders - i.e. they get cash back before shareholders if the
percentage is 25%,
then 60 options will
company is liquidated or have considerable risk-free upside
vest on the cliff if the company becomes successful. The value of warrants
date. for their holder is the difference between the exercise
Time price (strike price), which is typically set at fair market
Grant Issued Cliff Fully Vested Exercise value on the day of issuance, and the fair market value of
A contractual promise is A pre-agreed date Once options are Usually, option holders exercise the company’s share price on the day of exercising. For
made to the employee upon which the first vested, they can be on “exit”, or when leaving the
that he will be able to portion of the grant’s exercised. company. However, sometimes
example, a warrant with an exercise price of £10.00 which is
exercise a certain options vest. they partially exercise during the exercised at a share price of £100 represents a £90.00 gain.
number of shares for a vesting period (before the grant
fixed price in the future. vests fully), and other times they
can only exercise when certain The warrant holder will look for the share price to exceed
conditions are met. the exercise price before the expiration date to get the
benefit. If the share value has not exceeded the exercise

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The Cap Table – From Company Formation to Exit

price, the warrant is rendered worthless and the holder can between the market value of the shares at the time of However, the key word for employees in this discussion is
simply allow it to mature without exercising. It’s important exercise and the option price. “potential” benefit. There is no guarantee that the options
to note that the gain does not necessarily materialise will ever actually materialise into cash. So how can the
in the form of cash at the time of exercise, but can also For startups, phantom shares are a flexible way of involving company and employee achieve a good balance between
simply become shares. Most warrants have long expiration employees and advisors in the growth of the company with professional and financial benefits?
dates - expiration terms of up to 10 years into the future are less legal and tax work compared to options and warrants.
common. Investors are not required to exercise warrants They are widely used in countries such as Germany, where In our example company, the founders are looking for the
but, as mentioned already, they will become worthless tax legislation is strict on equity remuneration. The downside best available talent, quickly realising that the best people
once they expire unexercised. Companies do not have to phantom shares for the recipient is that any resulting already have jobs - well-paying jobs! They receive a lot of
any responsibility to remind investors about the warrant gains will be subject to income tax rather than capital gains interest from candidates who are interested in swapping
expiration dates, so if you are investing in a company tax, which is often a higher tax bracket. their corporate job for a startup lifestyle, but the salary
through warrants it’s a good idea to set a reminder about the package can be a limiting factor for some candidates.
expiration date. Equity and Cash Split The solution for these cases is issuing options. The new
employees can afford a small cut in salary against an
Phantom Shares How many options should a company give employees upside in options. By using options the company can sell
and what is the optimal split between cash and options to the entrepreneurial dream, being part of the team and the
Don’t let the name to mislead you - a phantom share ensure employee motivation? The internet is full of advice potential of participating in a big exit someday in the future.
is neither a share nor an option. It is a cash bonus plan and calculation methods for distributing the optimal number
that ‘walks and talks’ like a share option plan. A phantom of share options. In reality, the answer is that there is no
share option will never result in the company issuing an recipe. It’s all up for negotiation between each particular
option to the holder, but the amount of the bonus is tied company and its employees.
to the number of vested options and market value of the
company’s shares. From a company’s point of view, options are a great way
of remuneration. The employee has to buy the option at
In a phantom share plan, the recipient is granted an option exercise price and is only compensated for the value they
over a number of shares at a pre-set option price which is help create for the company. It’s cheaper than cash, and
usually - as it is with options and warrants - the company’s simultaneously helps align the team towards one common
share’s market value at the date of the grant. The option will goal. For the employee, options represent a potential asset
vest over time so that the holder’s rights to bonus increase that can be worth much more than a salary. For example
over time to reflect the fact that he or she has contributed Facebook’s IPO created more than 1000 new millionaires
to the value of the company. Upon exercising the option, the and multiple other IPOs have the same for employees.
holder receives a cash bonus equivalent to the difference

12
 The Cap Table – From Company Formation to Exit

Convertible Note
In this chapter, we will explain what a convertible note • Maturity Date: This denotes the date on which the note
is, when a company should consider raising money on a
Standard Convertible Notes is due, at which time the company needs to either raise
convertible note, and how it affects the cap table. A standard convertible note is a form of short-term debt that qualified financing or repay the note.
converts into equity, typically in conjunction with a future
• Qualifying Financing: An amount invested in a future
financing round. Here’s how it works: the investor loans
funding round which will provide the company with a
money to a company, which can carry interest, although not
decent runway and will trigger the conversion of the
always. When paying back the loan’s principal plus interest
note.
(if any), the company can pay the investor back with either
cash or equity, in the form of shares. A convertible note
holder does not SAFE Note
have voting rights in the company before the note has A SAFE (simple agreement for future equity) note can
been converted. A standard convertible note agreement will substitute a convertible note, but is often considered as a
usually stipulate terms like: simpler solution in the sense that it takes the form of a five-
page document, where no terms other than the valuation
• Discount Rate: A valuation discount which noteholders cap and discount rate are negotiable. SAFE notes were
will receive relative to investors in the future financing initiated back in 2013 by the accelerator Y Combinator, with
round, which compensates the note holder for the risk the aim to simplify the process of raising seed funds for
of investing earlier. startups, by removing interest rates and maturity dates from
the agreement.
• Valuation Cap: The highest possible company valuation
at which the note can be converted into equity. It Although SAFE notes are convertible security (i.e. they
protects convertible note holders if the company raises can convert into shares later on), they are different from
its next round at a valuation that exceeds the valuation convertible notes in that they do not create debt and mount
cap. up interest. Similarly to options, a SAFE note simply offers
its holder the opportunity to buy shares at some point in the
• Interest rate: Standard convertible notes typically future, typically at a discount.
accrue interest on market terms. It is a compensation
to the investor for the time the note is outstanding. 1. There are four types of SAFE notes:
Accrued interest will be added to the principal and
increase the number of shares issued upon conversion. 2. Valuation cap, no discount

13
The Cap Table – From Company Formation to Exit

3. Discount, no valuation cap The main benefit to investors is that ASAs can qualify for Following the Seed Investment, the company had budgeted
SEIS/EIS treatment, giving investors a tax incentive to buy with a runway of 18 months to reach Series A. They have
4. Valuation cap and discount into the company. In order to qualify for SEIS/EIS the ASA will hired the first employees, the product is on the market, and
convert into ordinary voting shares. they have some initial customers. But after 12 months,
5. No valuation cap, no discount, most favoured
it appears that they are falling a little behind targets.
nation (MFN) clause. Investors normally receive the shares they are entitled Accepting that they cannot achieve Series A with the
to during the company’s next funding round, provided desired metrics and likely not at the desired valuation, they
While SAFE notes offer companies and investors a faster,
that the company reaches a certain target that has been decide to postpone until the business metrics are in place.
more affordable way to complete transactions - which
predetermined in the ASA. If the company does not reach Management thinks they will need an additional 6
might be a great advantage, especially in the early stages of
this target, then the investor receives his/her shares by a
a startup - they offer less flexibility and potential for future
certain ‘ultimate’ date - formally known as the Long Stop months and £1 million to achieve the desired milestone.
negotiations. That’s why opinions vary about whether they
Date - and the number of shares he/she will be allocated This is obviously an issue that has to be addressed. A bank
are preferable to convertible notes, and one could argue that
is determined by a certain fixed price - known as the Long loan is not feasible with small revenue and large cash burn.
this depends on the interests of the specific investor and/
Stop Price. Both Long Stop Date and Long Stop Price are Equity investment would require valuing the business and
or company.
agreed upon from the beginning in the ASA. In the event could set a benchmark for the upcoming Series A. As a
that the company becomes insolvent before the qualifying result, attention falls onto a convertible note.
Further reading on SAFE notes funding round, the investor might be paid back in cash. If
If you’d like to dig a little deeper on the topic, the company is sold before the qualifying funding round, The same category of investors who showed interest in
Upcounsel gives some great insights here. shares will normally be issued right before the funding round the first round will usually have an interest in a convertible
at the sale valuation or at a discount. In all three scenarios, note at this stage. The company has matured a bit and thus
the exact way of compensating the investor depends on reduced investment risk, but there is still an opportunity
to get in before Series A at a lower valuation. Knowing this,
Advanced Subscription what has been predetermined in the terms of the ASA.
the company is assisted by its seed round investors with
Agreement When to Use a Convertible Note introductions to potential new investors. They quickly get
a couple of offers from investors who are interested in
An Advanced Subscription Agreement (ASA) is used in investing £1 million through a standard convertible note with
A convertible note is used when a company and investors
the United Kingdom, and also resembles the convertible 5% annually compounding interest rate on a day model with
cannot agree on a valuation for the company. There can be
note but this time in terms of being treated as debt on the 365 days/ year. The valuation cap is set at £10 million and a
multiple reasons for this. Typically if a company is at a very
balance sheet until a company’s next funding round. Both 20% discount rate to the next investment.
early stage (for example, idea stage), it can be difficult to
documents constitute an equity agreement, however unlike
agree on a specific valuation and thus smart to postpone
convertible notes ASAs cannot be paid back in cash, do not
the decision until a later funding round when the company
carry interest, and do not need to be repaid within a fixed
has matured. It can also be the case that a company has
period of time. They are simply a way for investors to pre-
urgent capital requirements or needs a little extra runway to
pay for shares that will be issued during a future funding
achieve the next stage of development. Using our company
round at a discount.
as an example again, a likely scenario for a convertible note
could unfold as follows:
14
 The Cap Table – From Company Formation to Exit

The Company’s Fourth Cap Table

Accepting an offer from a seed extension investor, the
company now has the 4th version of their cap table. Notice
that the convertible note is listed as debt on the balance
sheet and does not yet have any equity ownership. Further,
employees have now vested options which are the options
that have been issued from the option pool and now can be
exercised by employees. The company can choose to issue
more shares to the option pool when all options have been
granted to employees.

Shareholder Ordinary shares % Ownership £ Value

Founders 200,000 70% £3,500,007

Seed Investor 57,142 20% £999,987

Employees
20,000 7% £350,000
vested options
Option Pool 8,571 3% £149,993
Convertible £1,000,000 +
0 0%
note interests
Total 285,713 100% £4,999,987

15
The Cap Table – From Company Formation to Exit

Series A
‘Series A’ refers to a company’s first venture capital Three VCs are expressing interest to invest; the VC with most One of the tasks at hand during the term sheet stage is to
investment round. The term is meant to reflect the first domain knowledge is appointed to be lead investor. The lead present a cap table for the investment round - both pre- and
issuance of preference shares - preferred A shares. In investor will be responsible for negotiating the investment post-money. To do so, the company first has to make a new
this chapter, we will take a close look at the Series A term deal terms with the company on behalf of all the investors. pre-money valuation and convert the outstanding note.
sheet, negotiations, and preferred shares. A VC round is more complex than the angel rounds which

Our company is now performing really well, growing fast,

the company has prior experience with and which can be Converting the Note
closed with a simple handshake. VCs are complex entities,
and sees several venture capital funds showing interest with investors of their own, and have to go through a strict The first step in organising cap table scenarios for the round
in investing. The company is generating revenue, but is selection process before any capital is committed. The is to convert the note from debt to equity. The note has
not yet cash-flow positive and will need a boost to achieve first step for a company raising VC money is to attract the accrued interest over the last year and the initial loan of
ambitious growth plans. The management decides it’s time attention of one partner. If the partner likes the business £1,000,000 has grown with £50,280.75 to £1,050,280.75.
for a Series A. The ambition is to raise £15M at a £20M pre- and its potential, they will present it to the other managing The updated cap table is looking like this:
money valuation to fuel international expansion. partners. The company will often be invited to present the
business in front of the partners, and if all partners agree on
the business they will proceed to the term sheet stage.
Ordinary
Shareholder % Ownership £ Value
shares
Term Sheet Founders 200,000 70% £3,500,007

A term sheet is a nonbinding agreement setting forth the Seed Investor 57,142 20% £999,987
basic terms and conditions under which an investment will Employees vested
20,000 7% £350,000
options
be made. A term sheet serves as a template to develop
more detailed legal documents. The key here is to agree Option Pool 8,571 3% £149,993

that the parties will negotiate and invest legal resources in Convertible note 0 0% £1,050,280.75
a deal. Total 285,713 100% £4,999,987

The company can bring their own term sheet, but most often
The company had agreed a valuation cap of £15,000,000
the VC will bring their term sheet to the deal. The term sheet
with their investor. This is the highest valuation that the
will typically map out a time frame within which the parties
loan can be converted to. It was also agreed to implement a
involved will negotiate between them, and not negotiate with
discount of 20% on all valuations lower than £15,000,000.
any other parties.

16
 The Cap Table – From Company Formation to Exit

The Series A investors will invest in the company at a pre- ways to determine the shares to be allocated and the price Prefer- %
Shareholder Ordinary A £ Value
money valuation of £20,000,000. Alas, the new valuation paid per share. Let’s see what happens to the allocation of ence A Ownership
is higher than the valuation cap for the convertible note shares to our new investors in two different scenarios: Founders 200,000 - 38% £14,000,063
and thus triggering the conversion of the note from debt
Seed Investor 57,142 - 11% £3,999,958
to equity at £15,000,000. The discount would only kick The Investor Friendly Approach
Employees
in at valuations under the cap and is no longer eligible vested 20,000 - 4% £1,400,006
for conversion. The company converts the debt round first, allocating their options
shares using the number of shares outstanding. Then,
Option Pool 8,571 - 2% £599,973
To calculate the number of shares after conversion, we using the revised number of shares outstanding, they
Convertible
allocate the new investor their shares, based on the amount 21,000 - 4% £1,470,007
need to find the pre-money share price. This can be done note
by dividing the valuation cap by the total number of shares: they’ve invested. Series A - 223,469 41% £15,000,000
£15,000,000 / 285,713 = £52.50 per share. Total 520,998 - 100% £36,470,007
We already converted the debt note in a previous chapter,
Knowing the share price, we can now divide the investment which led us to the following cap table:
The Founder Friendly Approach
amount by the price per share: £1,050,280.75/ £52.50 =
20,005 shares after conversion Ordinary
Shareholder % Ownership £ Value The company allocates both the convertible debt and the
shares
new investor shares based on the same amount of shares
Ordinary Founders 200,000 65% £3,500,007
Shareholder
shares
% Ownership £ Value outstanding. To calculate the allocations through this
Seed Investor 57,142 19% £999,987
method we will use the cap table pre-note-conversion.
Founders 200,000 70% £3,500,007 Employees vested
20,000 7% £350,000
options
Seed Investor 57,142 20% £999,987
Option Pool 8,571 3% £149,993 Shareholder Ordinary A % Ownership £ Value
Employees vested
20,000 7% £350,000
options Convertible note 20,005 7% £1,050,281 Founders 200,000 70% £3,500,007
Option Pool 8,571 3% £149,993 Total 305,718 N/A £6,050,268 Seed Investor 57,142 20% £999,987
Convertible note 20,005 0% £1,050,281
Employees vested
20,000 7% £350,000
Total 305,718 100% £6,050,268 The new investment of £15,000,000 at £20,000,0000 pre- options
money will result in: pre-money valuation £20,0000,000 / Option Pool 8,571 3% £149,993
outstanding number of shares 305,718 = £65.21 per share.
Convertible Note Shuffle Convertible note 0 0% 1,050,280.75

The conversion of the note results in a lower price per Total 285,713 100% £4,999,987
We previously explained the option pool shuffle. “Convertible share than if the note had not been converted. Now the Total 520,998 100% £36,470,007
debt shuffle” is a similar phenomenon which can appear in £15M investment is calculated as £15M / £65.21 = 223,469
relation to the conversion of convertible notes. In short, the new shares. The new investment of £15,000,000 at £20,000,0000 pre-
convertible debt shuffle impacts the shares allocated to an money will result in: pre-money valuation of £20,0000,000 /
investor, when a convertible note conversion is triggered by This leads to the following ownership percentage for the outstanding number of shares 285,713 = £70.00 per share.
an investment. Like the option pool shuffle, there are two investor-friendly approach:

17
The Cap Table – From Company Formation to Exit

The Series A investor will convert using the following

formula: £15M / £70 = 214,285 new shares.
Series A Negotiations a look at outcomes in the event of selling the company at
different valuations:
With an understanding of the two methods of debt Exit: £0 - £15,000,000
We also have to convert the outstanding convertible note,
conversion and their impact on ownership, the founders
which is done by using the valuation cap share price of Prefer- %
evaluate the best approach for them. They decide to take Shareholder Ordinary Monies out
£54 and converting the outstanding debt. So £1,102,500 = ence A Ownership
the founder friendly approach and negotiate the deal from
20,400 new shares. Founders 200,000 - 38% £0
that standpoint. So the post-money cap table scenario sent
to the investors is: Seed Investor 57,142 - 11% £0
This leads to the following ownership percentage for the
founder friendly approach: Employees
20,000 - 4% £0
Prefer- % vested options
Shareholder Ordinary A £ Value
ence A Ownership
Option Pool 8,571 - 2% £0
Preference % Founders 200,000 - 38% £14,000,063
Shareholder Ordinary A £ Value
A Ownership Convertible 21,000 - 4% £0
Seed
Founders 200,000 - 38% £14,000,063 57,142 - 11% £3,999,958
Investor Series A - 214,285 41% £0 - £15M
Seed Investor 57,142 - 11% £3,999,958 Employees Total 520,998 - 100% -
vested 20,000 - 4% £1,400,006
Employees options
vested 20,000 - 4% £1,400,006 The worst case is the company going under and having to
options Option Pool 8,571 - 2% £599,973
liquidate. The VC’s will get all proceeds up to £15M. In this
Option Pool 8,571 - 2% £599,973 Convertible
21,000 - 4% £1,470,007 example everybody is losing, but the VC at least has some
note
Convertible
note
21,000 - 4% £1,470,007 Series A - 214,285 41% £15,000,000 downside protection. Nobody wants this.

Series A - 214,285 41% £15,000,000 Total 520,998 - 100% £36,470,007

Bad Case Scenario:
Total 520,998 - 100% £36,470,007
Preference shares are standard in VC deals. VC investing is
about beating the odds and finding the unique investments Exit: £0 - £35,000,000
To sum up: in the VC friendly approach the VC ultimately
received more shares; in the founder friendly approach, the that can pay back 10, 50, or 100 times the initial investment. %
Shareholder Ordinary Preference A Monies out
However, it’s also about protection against bad investment Ownership
VC gets fewer shares. So how does one decide which one to
choose? The answer is that it depends on negotiations and outcomes through provisions, such as liquidation Founders 200,000 - 38% £7,826,621

the investors approach. We’ve listed some different opinions preferences. Seed
57,142 - 11% £2,225,656
Investor
in the section below.
The investors are looking to commit £15 million in the Employees
vested 20,000 - 4% £432,662
company, and insist on a liquidation preference with 1x options
multiple and participation rights. This will ensure that the
Further reading on convertible debt Option Pool 8,571 - 2% £0
investor is paid the first £15 million in the event of exit or
Take a look at AVC’s explanation of the subject. Convertible 21,000 - 4% £1,168,788
winding up of the company.
Series A - 214,285 41% 23,346,273
They will also participate in monies paid out after the first Total 520,998 - 100% £35,000,000
£15 million on an equal basis with other investors. Let’s take
18
 The Cap Table – From Company Formation to Exit

Although this is a better situation than the worst case

scenario, it is still a suboptimal result for VCs - i.e. a company Exit: £0 - £350,000,000
Further reading on liquidation preferences:
where growth stagnates and the value does not increase
post-investment. In this case, the liquidation preference Shareholder
Preference %
Monies out
Brad Feld offers a good overview here .
Ordinary
A Ownership
and participation right secure a small upside for the VCs.
However, this simultaneously puts founders, employees and Founders 200,000 - 38% £128,975,574
For even more detail, you might find
early investors in a financially worse position than before the Christian Knott’s coverage of the topic
Seed
57,142 - 11% £36,676,784 useful too.
investment. Notice that the VC receives a disproportionate Investor
amount back compared to their ownership percentage. Also, Employees
the options granted to employees have the same ownership vested 20,000 - 4% £12,547,557
percentage as convertible note holders, yet receives under half options
the payout. This is because the options have to be exercised Option Pool 8,571 - 2% £0 Series B-G
first, which means the employees have to pay the strike price
Convertible 21,000 - 4% £19,260,567
before getting actual shares. In this case, for reasons of You have probably heard about unicorns, meaning startups
simplicity, the exercise price is set to £17.50 and corresponds Series A - 214,285 41% £152,539,517
with a valuation of more than $1 billion. At first these were few,
to the seed investment. Total 520,998 - 100% £350,000,000 but now they’ve increased in number significantly and several
Before the Series A investment, shareholders only had to share have become decacorns - companies with a valuation of more
the £20 million exit proceeds among founders, seed investors, In a best case scenario, the company meets the VC metrics than $10 billion.
and employees. Now, because the company has not increased and exits at 10x the last valuation. Everybody wins. The VC still
the value beyond the £35 million post-money valuations, takes out the first £15 million, but it’s negligible compared to In recent years, it has become increasingly normal for
the VCs take out the first £15 million corresponding to their the windfall that comes for everyone else too. companies to avoid IPO’s and stay in the private market
investment, and participate in the remaining £20 million on longer. There are many reasons for this, but it’s clear that high
equal terms with other shareholders. This has happened in In the simple scenarios presented here, the takeaway should regulation of listed companies and a robust private equity
reality to many companies and is one of the reasons why
be: liquidation preferences are a downside protection for market are contributing factors. Companies simply do not have
founders are often hesitant towards liquidation preferences.
Nobody is happy about this outcome - founders, employees, VCs, that gives them the first right to the capital paid out of to go through the hassle of public scrutiny to receive large
and early stage investors are disappointed that the cash value the company. Founders should be aware that the liquidation investments anymore. The result is the occurrence of Series
has dropped significantly since the last funding round. The preference will seriously hurt their pay-out if things do not work B-G funding rounds.
VCs are also unhappy, as they have invested in a low growth out as planned. But, if things do work out, everyone can reap
company, spent considerable time on it, and possibly lost out significant benefits. As an example, Uber is one of the companies that have
on other opportunities. operated in the private market until a Series G round, which
they secured in 2016 with Saudi Arabia’s Public Investment

Fund as lead investor. Even later, in 2017 they secured a $10B

Softbank investment, but without a Series label on it.

Just as the term Series A was used for the first time a
company issued preferred shares, the subsequent series
is similarly tagged with a letter to indicate new categories

19
The Cap Table – From Company Formation to Exit

of preferred shares with the later rounds having seniority

over the previous rounds. This means that new liquidation
preferences can have preference over a previously issued
preference. In other words, if a Series B preference share has
liquidity preference, its holders will receive their money first,
then the Series A investors, and finally ordinary shareholders.

Further reading on funding rounds:

Startups.com have written extensively
on this topic

20
 The Cap Table – From Company Formation to Exit

The Exit
This is the dream scenario for a large number of startup
entrepreneurs, as well as what receives the majority of
M&A duration of time. This is put in place from the acquirers’
side, to ensure a smooth integration of the companies and
press coverage in the field. The exit is the point at which all This is by far the most frequent way for startups to exit. CB that the acquired team will continue to bring value after
shareholders - founders, investors, and employees - can Insights estimated that 97% of startup exits in 2016 where the transaction .
sell their shares to materialise their gains (or losses). For though M&A . Also, 44% of startups exits are companies that
venture-backed startups, there are two ways an exit can have not made it past their Series A. IPO
happen: M&A or IPO.
When a company is sold as part of an M&A transaction it is IPO stands for ‘Initial Public Offering’, and refers to the first
usually bought by a corporate, meaning a bigger industry time the company will offer shares to the public by listing on
player or competitor. Mark Suster, managing partner at a stock exchange. A company can IPO as part of a funding
Upfront Ventures has listed a number of reasons why a strategy and seek to raise capital this way. Companies such
corporate would buy a startup: as Tesla, Facebook and Uber all raised money when listing
on the exchange. Others, like Spotify , listed on the stock
1. Talent hire ($1 million/developer as a rule of thumb — exchange as a direct listing without raising any money, but
location matters) with liquidity for shareholders being their sole motivation.
This is an unconventional method, but Spotify might have
2. Product gap
started a trend that other tech companies will follow.

3. Revenue driver
As we saw in the stats from CB Insights, only 3% of exits
happen this way and the number of IPOs has declined
4. Strategic threat (avoid or delay disruption)
steadily for the last 30 years. So chances are slim that a
5. Defensive move (can’t afford a competitor to own it) company will make it here and choose IPO.

M&A transactions can be done with cash, stock of the For the venture backed companies that do chose an IPO,
acquiring company, or a combination of both. Investors there are several things to consider in preparation for
will typically be bought out at this stage, but the founders’ the event.
journey often continues even after the exit. At times, the
First, the valuation game: how can the company achieve a
founders and key employees will be part of the deal, having
high, yet reasonable, listing price? An interesting example of
to agree to a lock-up period with the acquirer in which
this has been Uber versus Lyft, both set to IPO in 2019 with
they will continue working for the company for a specific
comparable business models. The first to IPO could set a

21
The Cap Table – From Company Formation to Exit

market expectation for the second listing. It’s basically the the water cooler have started throwing around guesses dismantled and shut down. The negotiations in this phase
company fighting to keep the expectations high and then about when the company will reach unicorn status. can give the founders and employees a better position in
meet the markets expectations to secure the share price. the new company after the acquisition. As the bidders tire
As the company continues to grow, corporations are starting out and conclude their bidding, the company evaluates
Second, founders and existing shareholders have to to notice customers using the new company’s services. the offers.
consider a lock-up period (typically six months) where they After a while, the CEO hears about a corporation following
are not allowed to sell their shares. During this time they’ll the company and he arranges a meeting to find out what The best offer is made by the initially interested corporate,
be at the mercy of the market and can only spectate as the their interest is. During the meeting, it becomes clear that offering £175 million for the company, and requiring the
share price is going up and down. Often, if the company fails the corporation has been looking at the company’s market founders to vest their shares for 4 years after the exit to
to deliver on expectations the first two quarters, pre-IPO for a while, acknowledging that the service would be a secure the transition and integration of services. The vesting
shareholders will have seen their price go-down. good value addition to its existing offerings, but deeming is conditioned on the company achieving high revenue
the opportunity too small to act on. They explain that they targets and bringing the product to a new market. Founders
Thirdly, but most importantly: publicly listed companies are impressed with the company’s approach to the market believe the plans are viable, but also know that they’ll will
are subject to public and regulatory scrutiny. They have and achievements so far, that they are not ready to act on be challenging to achieve. During the negotiation, founders
to publish earnings and share their expectations on the an acquisition at this moment, but could be interested in a get through that they will be paid 20% of the exit fee upfront,
development of the business with investors as well as future investment round. and vest the remaining sum later on. Let’s see how funds
competitors. As a result, the administrative burden of are paid out to shareholders:
choosing the IPO route becomes huge on any company. This Walking away from the meeting, the CEO maintains the
is arguably the single reason why many companies chose to impression that the corporate has intentions of buying Shareholder Ordinary
Preference %
Monies out
A Ownership
stay private for longer. despite talking down their interest. After discussions with
the board and management team, the team decides to act Founders 200,000 - 38% £12,198,757
For a more detailed account of what to consider when doing on the corporate interest by approaching other potential Seed Investor 57,142 - 11% £36,676,784
an IPO, you can get a legal perspective from international bidders - the corporates competitors. Convertible
21,000 - 4% £9,108,507
law firm Fladgate LLP, experts in assisting companies in note
raising new equity, by reading the three-part guide they With this move, the company is following Mark Suster’s Series A - 214,285 41%% £80,043,736
wrote for Capdesk readers. advice we discussed in the M&A chapter, and assumes a Employees 27,500 - 6% £7,509,170
defensive stance rather than positioning itself as a revenue
Total 520,998 - 100% £175,000,000
A Likely (and Simplified) driver. The leveraging power of this move lies in the fact that
it is more expensive for a corporate to lose market share to
Exit Scenario a competitor than gaining a revenue from a startup in an
Most noticeable in the exit scenario is the founders slim
pay-out of £12 million compared to the investors pay-out
immature market.
The spirits are high in the company following its impressive due to the lockup provision. There is still £48,795,027 for
Series A round. The round has spun off a lot of positive In the end, there are two potential buyers left and the the founders to earn, but the founders struggle is not over
press. The improved recognition has helped the company company is now trying to get the highest price and the until the company has successfully integrated with the
acquire more customers and attract employees. All things best terms on the deal. Many entrepreneurs have sold to acquirer. Agreements like this can take several different
are pointing in the right direction and the whispers around a corporate only to see their work buried in bureaucracy, forms, but is typically based on milestones, period of time or
a combination.
22
 The Cap Table – From Company Formation to Exit

Summary
The pay-out to employees in this example is calculated on two
exercise values 20,000 options at £17.5 and 7,500 options at
£70.33. In other words, the employees will receive a payout
calculated on the basis of value of outstanding options -
In our discussion above, we introduced terms and concepts
exercise value:
related to companies cap tables and how decisions made
(27,500 x £335.89) - (£17.5 x 20,000 + 7,500 x £70.33). As early on in a company’s life will affect its shareholders
we’ve shown in earlier examples, the exercise price reduce the later on. We covered some essential subjects, such as how
actual payout to employees. instruments such as convertible notes will affect your cap
table, what liquidation preferences mean for exit proceeds,
The option pool shuffle. Remember the Seed Investor and how a company can take advantage of options or
receiving 7,142 shares more due to his understanding of the warrants to accelerate its growth.
option pool shuffle? At exit those shares are worth £2.4M. The company example we used is a simplification of how
What in the beginning seemed to be a negligible ownership companies organise their cap tables. As we saw, managing
percentage ended up as a lot of money. a company’s equity capital However, the real business world
is complex and equity registers in fast growing companies
Finally the Series A VC is taking the largest payout of all
are constantly changing. Options are issued on a continuous
shareholders. They hold the most shares and have liquidation
basis as employees keep joining the company, and lapse
preferences. Adding more categories of preferred shares
when they leave again. It is often when these changes occur
in a company will severely skew the payouts for existing
that companies lose track of their registers, and why it can
shareholders. Companies should be aware of this when raising
be a good idea to switch from a cap table spreadsheet to an
funds and run scenarios for how the investments will affect
online cap table.
payout at different exits.

23
The Cap Table – From Company Formation to Exit

Cap Tables
from Formation to Exit
Capdesk is a digital platform enabling businesses to save
thousands in legal and accounting fees, by managing cap
tables and employee share plans efficiently. Capdesk’s
vision is to empower private companies to share equity with
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For more information, visit www.capdesk.com

24