Over the years, I’ve seen quite a number of cap tables. From early stages where it is just two or three founders, to post Series B, where there’s all types of equity holding investors. I’ve also come across plenty of companies raising a Series A with already 10+ different names on their cap tables, leading to all kinds of complexities, delays and costs.

This article delves into the importance of maintaining a well-organized cap table. By being selective in who you include and by deploying alternative instruments you can effectively manage your cap table. We'll guide you through five best practices to ensure your cap table is a sturdy foundation rather than a source of complications.

A capitalization table, or ‘cap table’ is the overview that lists all shareholders in a company, as well as their share interests, voting rights and share type (Ordinaries, Seed, Series A etc.).

Best practice 1: Prioritize cap table organization

Having a well-organized cap table is essential for strategic planning and execution. Companies, regardless of their size or industry, benefit from swift decision-making and operational agility. Having only essential, trusted people on your cap table allows you to sprint through decisions.

But a tidy cap table is not just a blessing for day-to-day decisions. When the stakes are high and the equity round or exit talks begin, that's when your cap table steps into the spotlight. Each shareholder, no matter how silent they've been in the past, then has a voice. The fewer people you have to get on board (obtain a signature from), the faster you move.

Prioritizing cap table management also enables you to better deal with increasing complexity. The initial small group populating the cap table (angel investors and a handful of team members) will quickly grow into a large group (seed investors, Series A investors, an expanding workforce), thus making matters more complex. Having a “design” behind your cap table avoids the maze of who owns what in your company’s equity.

There is a number of software solutions that help with equity management, such as Carta and WeVestr. These tools offer a number of useful features and can certainly help you keep the overview, run scenarios and administer funding rounds as you expand. If you’re at the earlier stages of your venture and your goal is to simply list who owns what, an excel spreadsheet will often do.

Best practice 2: Selectively admit people to your cap table

When you don’t have the cash to attract advisors and talent, equity is a handy and seemingly cheap instrument to bind people to your company – in the short term. In the long run, it’s the most expensive gift to give and without clear agreements, it’s a nightmare to take it back. Therefore, you should be careful with who you hand it out to.

Clearly, you and your co-founders should be on the cap table. And so should your most important investors. For advisors and employees, it is also reasonable to seek financial compensation. They’ve spent time and efforts on your company, often against a low salary or fee. But that in itself does not justify equity, and all the voting rights that come with it. For these contributors, alternative equity solutions (best practice 3) and indirect equity (best practice 4) are typically a better fit.

Best practice 3: Deploy alternative equity solutions

Making thoughtful decisions upfront is crucial. Equity allocation is a long-term commitment, and retracting shares can be a challenging process. Luckily, alternative instruments can achieve similar goals with added flexibility.

When dealing with investors, it can be as simple as a loan. As most investors will eventually want an equity stake, a convertible loan (CLA) or a simple agreement for future equity (SAFE) can be sensible choices. At conversion, the investor will acquire an equity stake, but it does kick the equity-can down the road. This delay can also benefit you and your company in another way, as it allows you to grow and issue shares at a higher valuation. Note that convertibles should also be handled with care. Stacking convertibles with different terms such as interest rates, valuation caps, discounts and maturity dates can lead to a notorious ‘CLA spaghetti’ – loans that convert on terms that are incompatible with each other. It will take time and extensive excel spreadsheets to unravel.

When dealing with employees and advisors, stock appreciation rights (SARs) are an alternative to traditional equity or stock options. SARs essentially mimic the financial rights associated with actual company shares. They give the holder the right to receive exit proceeds and/or dividend distributions and are therefore also referred to as ‘virtual shares’ or ‘phantom stock’. From both legal and financial point of view, however, SARs are simply contractual rights to receive a cash bonus if specific conditions are met. This flexibility allows you to tailor SARs to your company's wishes and needs.

Fred Wilson, a prominent investor, is no fan of convertible notes. In his view, convertibles delay and muddy the discussion around who owns what. This isn’t necessarily the case. Running conversion scenarios at various valuations and amounts raised show the effect of a priced round on equity stakes. Although exact outcomes remain uncertain, running these scenarios sets expectations for investors and founders alike.

Best practice 4: Leverage indirect equity

If an informal investor insists on equity, or an employee is willing to commit savings to acquire a stake in the company, indirect equity makes a good option. With indirect equity, a special purpose vehicle holds the shares (including the voting rights) while all financial rights are passed along to the investors or employees. Common vehicles for indirect equity include foundations (Stichting Administratiekantoor or 'STAK'), B.V.s, or CVs, each offering certain fiscal benefits when structured correctly. Indirect equity offers two significant benefits compared to direct equity. First, it enables you to split the voting rights from the financial rights, simplifying your governance. Second, it pools different parties in one vehicle, reducing your administrative load.

Indirect equity is also a sensible solution for founders that have left the company. For the company, the ‘cleanest cut’ is a transfer of all this founder’s shares, avoiding a legacy-filled cap table. But this founder may have laid invaluable groundwork for the business, and it may be fair that they share in the financial growth that materializes on that basis. Unifying these interests, indirect equity allows them to partake in the future upside, while the voting rights are exercised by whoever controls the pooling vehicle (see text box).

Similarly for early stage investors: in the first months and years after their investment, they will hopefully say some smart things that help you and the business grow. But as you grow, you might outgrow their expertise. Their financial contribution – no matter how appreciated in the early stages – will seem small in comparison to the investments of later stage investors, and their share percentage will dilute with each funding round. Having early-stage investors with micro stakes on your cap table does not match your goal of agile governance. Pooling them in a vehicle allows them to maintain their financial interests, while enabling your company to continue with swift decision-making.

With indirect equity, be mindful to choose the board of your pooling vehicle wisely, as these are the people that will exercise the voting rights. Ideally, your company should be in control, especially when dealing with employees or former founders. However, for investor pooling vehicles, it's quite common to have one or two of the pooled investors represent the interests of others.

When issuing convertibles or direct equity, pre-emption is key. A simple clause in the CLA or SAFE ensures that the investments are converted into indirect equity and the investors are pooled into one vehicle. If an investor has direct shares, anticipate diluted stakes by including in the shareholders agreement that if their stake dilutes to below 5%, they swap their direct shares to indirect shares via a pooling vehicle.

Best practice 5: Regularly clean up a crowded cap table

Maybe your cap table already is a mess, and that’s why you’re here. Don't worry; you're not alone and in most cases, it can be fixed. But that requires rearranging the cap table and that is neither an easy nor pain free process. The first step is to decide who on your cap table should no longer be a (direct) shareholder. That’s the easy part.

The next step is to get all relevant persons to agree, and that requires meticulous stakeholder management, persuasion and perhaps negotiations. Obtaining a tax lawyer’s advice may be beneficial, as a pooling vehicle can provide certain tax benefits for the shareholders with a stake below 5%. The best time to address this is during an equity round. Leverage the new investor, the money they bring in and the dilution that follows to bundle shareholders with a smaller stake into a pooling vehicle.

To summarize

Maintaining a clean cap table is not just about tidiness; it's essential for the efficient operation and future success of your company. By carefully selecting who belongs on your cap table and employing smart strategies, you can avoid the complexities and headaches that arise from a cluttered ownership structure.

Remember, giving shares is easy, but taking them back is challenging and expensive. Prevention is the best policy when it comes to cap table management. Need someone to help you navigate? Reach out to Marieke Pols or one of the other corporate partners of De Roos to discuss how we can help.