Welcome to the final post of Tandem Innovation Group’s first blog series: Startup Financial Management 101! In this four part series, we provided the basics on managing your startup’s finances. From breaking down key concepts, to providing tips, and illustrating through examples; this series is the go-to resource for entrepreneurs. Curated with the expertise of Tandem network professionals, we want to make it simple for you to understand your startup’s finances.
Today we are looking at cap tables and stock options. We will be explaining what these are, why they are important, and how you can use them to propel your startup to the next level.
What Are Cap Tables?
Capitalization tables, otherwise known as “cap” tables, are a breakdown of a company’s shareholders’ equity. Cap tables show all of equity ownership capital, including common shares, preferred shares, options, and convertible equity. They list out each type of equity ownership, the individual investor, and the share prices/investments.
What Are the Different Fundraising Rounds?
There are five key fundraising rounds, each of which involves a different type of investor and stage of company development.
The Seed round generally involves a raise between $500k- $2M. With a valuation of approximately $3-6M. Anything before that is a pre-seed. Anything more than that can sometimes be considered a Series A where you are raising between $2-$15M, where the valuation is between $10-$30M. Your valuation will likely depend on how much you need and how much you are willing to give up.
|Stage of Company||
|Pre-Seed||Selling the founder’s idea.||Family & Friends, small Angels|
|Seed||Have a concept / business plan you want to prove.||Angels, Accelerators / Incubators, small VCs|
|Series A||Proof of concept exists, need funding to ramp up.||VCs, large Angels|
|Series B||Scaling, geographic / product line extension, team expansion.||VCs, small PE|
|Series C||Growth, build market position, strategic acquisitions, maybe starting to plan exit.||PE|
What Are Employee Stock Options?
Employee stock options are a type of equity compensation for employees. Instead of granting shares of stock directly, the company gives derivative options on the stock.
There are pros and cons to this compensation structure;
- Recruit top talent
- Align employee incentives
- No loss of control (typically no voting rights)
- Employees share in company upside
- Arguably no cash cost to company
- Advantageous tax treatment for CCPCs
- Dilutive to existing shareholders
- Forego opportunity to issue shares for additional cash
- Expense for accounting purposes
- Program administration
There are six key characteristics that define each stock option;
Grant price/exercise price/strike price – the specified price at which your employee stock option plan says you can purchase the stock
Issue date – the date the option is given to you
Market price – the current price of the stock
Vesting date – the date you can exercise your options according to the terms of your employee stock option plan
Exercise date – the date you do exercise your options
Expiration date – the date by which you must exercise your options or they will expire
What Are Preferred Shares and Convertible Debt?
Common shares are more suitable for long-term growth investors. Preferred shares and convertible debt are better for more risk-averse, yield seeking investors who still want some upside potential.
The follow compares common shares, preferred shares, and convertible debt on seven key dimensions;
|Common Shares||Preferred Shares||
|Redemption Value||None||Yes||Yes (face value)|
|Dividends||Only paid when declared||Fixed, regular dividends
Can be deferred
|Mandatory interest payments|
|Tax Treatment||After-tax dividends||After-tax dividends||Pre-tax interest|
|Voting Rights||Pro-rata to number of shares||None||None|
|Redeemable / Retractable||No||Sometimes
Can also be convertible
|Liquidation Preference||Last||Ahead of Common Shares||Ahead of all Equity|
|Upside Potential||Unlimited||Limited to redemption value (unless convertible)||Limited to face value (unless convertible)|