The cap table explained

A cap tableEquity & financingCap tableThe register of who owns what in a company — every share issued, every option granted, the unissued pool and every SAFE or note that will become shares — shown as share counts and as percentages, issued and fully diluted. It must agree with the stock ledger, the board consents and the books is the register of who owns what: every share issued, every option granted, the unissued option poolEquity & financingOption poolShares the board reserves under a stockholder-approved equity plan for future grants of options and other awards. Granted options and the unissued remainder both count in fully diluted shares, and every SAFEEquity & financingSAFECash from an investor in exchange for a right to shares in a future priced round, usually at a valuation cap or a discount. Not debt and not yet stock; because a SAFE can require cash on a change of control, it is often classified as a liability under ASC 480 and remeasured at fair value — the terms decide or noteEquity & financingConvertible noteDebt that converts into stock at a future financing, usually at a discount or a cap, accruing interest until it does — a liability until conversion, with any embedded conversion feature assessed for separate accounting that will become shares. It is the document the board consents, the stock ledger and the balance sheet all have to agree with, and the first thing an investor's lawyer rebuilds.

Founders and employees hold common stockEquity & financingCommon stockThe residual class of shares — founders', employees' and option holders' — paid after creditors and after any preferred stock's preference. The class a 409A valuation prices. Investors in a priced roundEquity & financingPriced roundA financing in which investors buy a new series of preferred stock at a stated price per share, on a negotiated pre-money valuation — as opposed to a SAFE or note, which defers the price. Converting SAFEs and notes convert at its close buy preferred stockEquity & financingPreferred stockA class or series of stock with rights common lacks, set out in the charter — usually a liquidation preference, conversion into common, anti-dilution protection, protective provisions and board seats. What investors buy in a priced round, and what a SAFE converts into — a series with rights common lacks, written into the charter: a liquidation preferenceEquity & financingLiquidation preferenceA preferred stockholder's right to be paid a stated amount — usually 1× the original issue price plus declared but unpaid dividends — before common stockholders in a sale or liquidation. Non-participating preferred takes the greater of that or its as-converted share; participating preferred takes both, conversion into common, anti-dilution protectionEquity & financingAnti-dilution protectionA charter provision that lowers preferred stock's conversion price when the company later sells stock below it. Broad-based weighted average moves it part way, by CP2 = CP1 × (A + B) ÷ (A + C); full ratchet moves it all the way down to the new price, protective provisionsEquity & financingProtective provisionsActions the company may not take without the consent of a set majority of the preferred — selling the company, changing the charter against the preferred, creating a senior class, changing authorized shares, paying dividends, changing the board's size and board seats. That is why a 409A appraisalEquity & financing409A valuationAn appraisal of a private company's common stock at fair market value, so options granted with a strike at or above it avoid the tax penalties of IRC §409A. A tax safe harbor; the books measure option expense under ASC 718, often starting from the same common-stock value prices the common below the round's price: the two classes are different securities.

The pre-money valuationEquity & financingPre-money valuationWhat a company is priced at immediately before new money comes in. Pre-money ÷ pre-money fully diluted shares is the round's price per share — so whatever the term sheet puts in the pre-money (converting SAFEs, a bigger option pool) is paid for by the existing holders is the company's price immediately before the new money; the post-moneyEquity & financingPost-money valuationPre-money valuation plus the new money. An investor's ownership is its investment ÷ post-money; a post-money SAFE's cap is stated this way, so the SAFE's ownership is known the day it is signed is that plus the money. Northwind's planned Seed: $8,000,000 pre-money plus $2,000,000 is $10,000,000 post-money, so the new investors own $2,000,000 ÷ $10,000,000 = 20.00% after the round. The price per share is pre-money ÷ pre-money fully diluted shares — and what counts in those shares is the most negotiated line in a term sheet.

$2,000,000 ÷ $8,000,000 pre-money = 25.00%.

$2,000,000 ÷ $10,000,000 post-money = 20.00%.

In this lesson: fully diluted versus outstanding, with Northwind's table both ways.