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How to Improve Cap Tables for Entrepreneurs
A Capital Table, also known as a preferred or common equity table is a financial table listing the economic terms of various entities during different stages of financing. A Capital Table is prepared for a particular need such as acquisition of a business, the integration of an existing business into the larger organization, partnership financing, debt consolidation, ownership change, lease negotiation, ownership option valuation and other such needs. This allows one to adjust the financial performance of the business through time, when it may otherwise be difficult to do with the traditional Statement of Ownership. The use of a Capital Table is highly useful and in many cases it forms an integral part of the process of obtaining funding for any business venture.

The basic purpose of a capital table is to ensure that a reasonable proportion of the ownership in any company is transferred to the investors on different stages of its development. The most widely used method of creating a capital table is to first create a list of all the owners in a company, then divide the total number of shares held by each of them into smaller multiple-shareings. The capital table is then constructed on the basis of the proportionate shares of the total number of the shares and the percentages of ownership among the founders. A Capital Table can be based on different assumptions for the type of financing sought; for instance, if one is considering lenders' preferred capital structure, it may be based on percentages of interest that the partners would receive from the lenders instead of actual amounts they would receive from them.

The purpose of the capital structure is to ensure that startup entrepreneurs and early investors are not given undue control over the business in the hands of less than productive or reckless participants. The Cap Table provides information about the income and liquid capital of the company as well as its tangible and intangible assets. The three sections of the Cap Table are Liquidity: Current and Perishable Financing, and Equity Compensation: All Other shareholders and Startup Entrepreneurs. The Startup Entrepreneurs section provides information about the startup entrepreneurs and their experience, track record and capital and equity considerations.

Equity Compensation is divided into two parts, namely Users and Owner. The Equity Compensation ratio is used to indicate how well an individual or firm is performing financially. Investors can view this ratio as an expression of how well the company is doing compared to similar companies in the market. The two perspectives on equity compensation are practical; the ideal value of an ownership interest is equal to the value of the cash invested. However, some companies use the value of the stock option and warrant as their own measurement of equity. For investors who are looking at a particular market leader, it is important to be aware of the potential conflicts of interest.

The use of Cap Tables can really be quite confusing and misleading. For example, many people mistakenly believe that they are simply comparing apples to apples when they are actually comparing shares of ownership. Thus, they are comparing "worth" or capital value or book value to the price per share. To understand Cap Tables better, it is essential to know exactly what they are looking at. The Cap Table, also known as enterprise value (EV) is the amount by which market capitalization is less than the net worth of the company. This is the exact opposite of diluted EPS; where the EPS represents the difference between actual cost of capital paid in to the company and its net worth.

Another confusion regarding Cap Tables is regarding the method of allocation between the different components of the Cap Table. Many companies allocate funds in different ways, such as through an option pool or another form of diversification. Often, however, some of these companies' shareholders will receive less than the entire capitalization of the company. As such, when an investor is looking at a Cap Table, he or she must determine if allocating funds between the different components of the Cap Table makes sense. If not, then the investor must determine if the distribution of capital is indeed fair and consistent with the shareholders' interests.

Over the last two decades, I have written over 80 articles on how to improve Cap Tables. In one of my articles, I described three strategies that can easily change and improve your Cap Table, or, as I often refer to it, your LTM (land, money, labor, capital). One of these strategies is to easily change the allocation of your labor force between human capital, or some combination thereof. Allocating human capital between different categories of employees can be extremely difficult because of differentials in productivity, incentives, motivation, and other factors.

The second strategy that I described in that article is to use an employee stock ownership plan (ESOP) to provide your employees with a portion of their profits. Investors who purchase ESOPs can then easily move the money from the restricted funds of the company to the equity of the startups they are investing in. However, some ESOPs require the employee to be a member of the company for a specified amount of time before distributing any of the company's profits. The third strategy is to use an employee leasing program (EFLP) to provide your employees with shares of the profits of the startups . The third strategy requires that you first provide your startups with free office space, computers, phones, Internet service, etc.
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