Ownership structure of a business changes whenever new investors come in, as new shares may be issued or existing shares are sold. A capitalisation table (“cap table”) becomes essential for any business looking to scale, raise funds or undergo partial M&A transactions.
This article explains why founders should maintain a cap table and, where dilution arises, how it can be managed.
How a cap table works
A cap table is a record of a company’s ownership structure. For early-stage companies, the cap table is usually simple and maintained in a basic spreadsheet with the following:
- shareholder names
- number of shares held by each shareholder
- percentage ownership
A cap table also reflects any transfer of shares. In such cases, the ownership is reallocated while the share capital remains unchanged.
The complexity arises when the company goes through funding rounds. The cap table becomes more detailed and evolves into a working tool that tracks how ownership changes over time. It may then reflect:
- changes in ownership across different funding rounds
- amount of equity offered to investors
- types of shares issued (such as ordinary or preference shares)
- issue price of shares
- conversion outcomes of convertible instruments
- fully diluted ownership
At this stage, the cap table is used to model different funding scenarios and is often reviewed by investors.
When to update a cap table
A cap table should be prepared and updated before each transaction as it is primarily a forecasting tool. Updating it in advance allows founders to:
- assess dilution impact before committing
- understand how ownership and control will change
- align valuation, share issuance and deal terms
How dilution happens and managing it
Dilution occurs when new shares are issued, whether through fundraising rounds, employee share option schemes, or the conversion of instruments such as preference shares.
For example, a founder may start with 100% ownership. After issuing shares to investors, this may drop to 70% or lower. Over multiple funding rounds, this reduction can become significant if it is not planned from the outset.
Managing dilution through valuation
A cap table should be used alongside valuation as a planning tool by modelling different funding scenarios.
If a company is undervalued in the initial round, founders may give up more equity than intended. This sets the baseline for future rounds, and subsequent fundraising may further dilute ownership, including loss of majority control.
Where convertible instruments are involved, dilution may not be immediate but can arise upon conversion. Different conversion terms (such as pricing adjustments) may result in varying levels of dilution, which should be modelled in advance to avoid unexpected outcomes.
Managing dilution through contractual protections
Where loss of majority ownership is expected, founder protection should be negotiated and reflected in a shareholders’ agreement to preserve decision-making rights.
Key takeaways
- Cap table is a forward-looking tool to plan ownership, model dilution and support transactions.
- Early valuation and proper cap table planning determine how much equity founders give up over time.
- Where losing majority ownership cannot be avoided, shareholders’ agreements are used to preserve control and decision-making rights.
Let ELP support your business transactions
Once your cap table, valuation and deal structure are settled, we can assist in translating these into clear transaction documents, including the drafting of investment term sheets, Shareholders’ Agreements and other transactional documents.
