Understanding and effectively managing a cap table is not just a task, but a key to the success of any startup, particularly those in Malaysia looking to raise equity funding and expand their business.
A cap table, or capitalization table, is a detailed record that outlines a company's ownership structure, including the distribution of various types of equity, such as common shares, preferred shares, options, and convertible securities.
For Malaysian startup founders, maintaining an accurate and up-to-date cap table is not just a necessity, it's a strategic advantage. It provides clarity in ownership, aids in making informed business decisions, and is indispensable during fundraising efforts.
By understanding key components like initial ownership, investor stakes, stock options, and the implications of dilution, founders can navigate the complexities of equity management. Utilizing cap table management software, adhering to local regulatory requirements, and ensuring regular updates are crucial steps in managing a cap table effectively. This article aims to equip Malaysian startup owners with the knowledge needed to build, manage, and understand cap tables, thereby preventing common early-stage mistakes and fostering long-term business success.
What is a Cap Table?
A cap table or capitalisation table is a spreadsheet that lists all owners in company equity and describes how many shares are held by the investors, employees and founders. The purpose of having a cap table is to be able to track the financial interests of the company’s stakeholders.
The key components of a cap table are as follows:
Founders and initial ownership in cap table
Initially, the founders own full ownership of the company. Eventually, they will exchange a portion of their company’s equity in return for their stakeholders' commitments, such as capital, time, or expertise.
Investors
Founders usually approach certain groups of people, including family and friends, angel investors, venture capitalists, or strategic partners, to raise money for their company.
Share options and warrants
Share options are normally granted to employees and advisors who perform services for the company. Warrants are financial instruments that give the holder the right to purchase shares of the company at pre-determined prices in the future such as Simple Agreement for Future Equity (SAFE).
Convertible securities
Convertible securities are usually bonds or preferred stocks/shares that can be converted into common shares.
Ownership percentage
The ownership percentage is determined by the number of shares owned by the shareholder divided by the total outstanding shares multiplied by 100. Outstanding shares are any shares held by shareholders and company insiders.
Dilution tracking in cap table
When new shares are issued, the ownership percentage of each existing shareholder decreases. This occurrence is called dilution. A fully diluted cap table indicates all possible prospective equity financing sources.
Importance of Cap Tables for Startups
As a startup, it is important for you to create a cap table for numerous reasons.
Crafting An Effective Fundraising Roadmap By Referring Back to Cap Table
Having a cap table is essential for startups to keep track of the money invested in each round of fundraising stages. Startups will be able to strategize fundraising and monitor the dilution percentage as they undertake fundraising exercises. Therefore, startups can make a sound decision not to over-raise, which ultimately leads to an undesired reduction of the voting power of the founders or existing shareholders.
Clarity In Ownership Structure in Cap Table
A cap table shows a company's entire ownership structure. Startup business owners and potential investors can then quickly access relevant information about the company's equity.
Essential for fundraising efforts
Raising capital is often a necessary step for a startup's growth and expansion. A cap table is a key document that potential investors scrutinize to understand the company’s financial structure and ownership dynamics. It helps investors assess the potential risks and rewards of investing in the startup. A transparent and well-organized cap table can instil confidence in investors, making it easier to secure funding. It also helps founders present a professional and organized image, showcasing their readiness for investment.
Helps in making informed business decisions with clear shareholdings status in cap table
Cap tables play a crucial role in strategic planning and decision-making. They provide insights into how different decisions will affect the company’s equity distribution. For instance, when planning to issue new shares, grant stock options, or undertake a new funding round, the cap table helps predict the impact on existing ownership and potential dilution. This foresight allows founders to make informed decisions that align with their long-term goals and minimize adverse effects on existing stakeholders.
Facilitates Transparency with Stakeholders
Transparency is vital in maintaining trust and confidence among all stakeholders, including investors, employees, and board members. A detailed and regularly updated cap table ensures that all parties are aware of the current ownership structure and any changes that occur. This openness helps prevent misunderstandings and disputes over equity distribution. Additionally, it provides a clear record for legal and regulatory purposes, ensuring compliance with local laws and regulations.
Managing Your Cap Table Effectively
Startups must decide who will be responsible for creating a cap table in the company. Normally, the chief executive officer (CEO) will oversee the management of the cap table since the CEO is responsible for fundraising and often has the strongest relationship with investors. As the company grows, managing the cap table will be the responsibility of the most senior finance leader.
Ensuring all entries are up-to-date and accurate
Accuracy is important in cap table management. Every entry must be precise and reflect the actual ownership and equity transactions. This includes recording the issuance of new shares, stock options, and any changes resulting from funding rounds or other equity events. Regular audits of the cap table can help ensure that all information is current and correct. The person in charge should cross-check the records with legal documents such as shareholders' agreements, investment agreements, and option grants to verify accuracy.
Maintaining accuracy in the cap table can be much easier if startups centralise data from their systems so that it can be accessed from one source based on the single source of truth (“SSOT”) principle. With SSOT, startups can improve the data quality in their organisations. It prevents different teams in the organisation from disputing the reliability of the dataset.
Using cap table management software
Using dedicated cap table management software can greatly simplify the process. Tools like Carta, Capshare, and Eqvista are designed to handle the complexities of equity management, providing a user-friendly interface to track ownership, manage stock options, and model dilution scenarios. These platforms often come with features such as automatic updates, compliance tracking, and reporting capabilities, which can save time and reduce errors. Additionally, they offer secure storage of documents and easy access for stakeholders, enhancing overall transparency and efficiency.
Adhering to Malaysian regulations and legal requirements
In Malaysia, startups must adhere to local regulations and legal requirements concerning equity and shareholder documentation. This includes compliance with the Companies Act 2016 and other relevant laws. Ensuring legal compliance involves keeping accurate records of share issuances, maintaining proper documentation for all equity transactions, and filing necessary documents with the Companies Commission of Malaysia (SSM). Engaging with legal advisors who specialize in corporate law can help ensure that the company stays compliant with all regulatory obligations, avoiding potential legal pitfalls.
Keeping the cap table current with every change in equity structure
The cap table must be updated regularly to reflect any changes in the company’s equity structure. This includes new equity investments, the exercise of stock options, issuance of new shares, or changes due to convertible notes being converted into equity. Regular updates ensure that the cap table accurately represents the current ownership structure, which is crucial for decision-making and financial planning. Establishing a routine for updating the cap table after every significant equity event can help maintain its accuracy and reliability.
Maintaining transparency with investors and shareholders
Maintaining transparency with investors, shareholders, and other stakeholders is essential for building trust and confidence. A clear and up-to-date cap table provides a transparent view of the company's equity distribution, which is important for current and potential investors. Regular communication about changes in the cap table, such as new funding rounds or significant equity events, helps keep stakeholders informed and engaged. This transparency can prevent misunderstandings and foster a collaborative environment where all parties are aligned with the company’s goals.
Working closely with corporate lawyers to manage your cap table
It is recommended that startups get corporate lawyers to manage the cap table and work closely with their teams. This will reduce long-term legal bills, as startups will not be required to do legal cleanup on the cap table later, which may take long hours.
Corporate lawyers can advise startups on legal issues related to fundraising. The other role of corporate lawyers is to monitor various legal documents affecting the cap table, such as subscription agreements and convertible notes. Experienced corporate lawyers will be able to strategise fundraising plans for startups to ensure compliance with legal requirements. Furthermore, corporate lawyers can assist startups in preparing and reviewing the startups’ internal documentation, which is required for legal due diligence. This is to ensure that such documentation is properly documented and made available when the fundraising exercise is undertaken. Corporate lawyers can prepare the required legal documents for fundraising that ultimately impact the cap table and founder’s shareholding.
Understanding the Malaysian Context For Cap Table
Regulatory Environment
There is no legal requirement under the Companies Act 2016 or relevant laws in Malaysia for a company to record the company’s information through a cap table. Nevertheless, it is required under the law for the company to keep registers and statutory books. This allows investors interested in the company to access its records and information. Startups need to properly ensure that the following registers and records are kept and adhered to the requirements under the Companies Act 2016 (“CA 2016”):
Register of Members (S.47(3), 50, 51 and 568 of the CA 2016);
Index of Members (S.52 and 54 of the CA 2016);
Register of Directors’ Shareholdings (S.59 of the CA 2016);
Register of Substantial Shareholders (S.136 of the CA 2016);
Register of Debenture Holders (S.60 of the CA 2016);
Register of Interest Holders (S.152 of the CA 2016; S.2(1), 44 and 76 of the Interest Scheme Act 2016);
Register of Beneficial Owners (S.60B, S.60C, S.60D and S.60E); and
Lodgement of Annual Return (S.576 of the CA 2016).
Investment Landscape
At the early stage, startups have a few channels to which they could go for fundraising, namely venture capital, private equity, or accelerators and incubators.
Venture Capital
Venture Capitalists often start financing at the seed stage when the company has an idea for a product or service that could potentially develop into a successful business. The final stage of venture capital financing is when the company has reached maturity. They will opt to sell their shares in the Company at the stage where the company going public through Initial Public Offering (IPO), or completion of a mergers & acquisitions exercise. Normally, they may request preference shares without voting rights and dividends of around 7% per year.
Private Equity
Private Equity Firms normally invest in mature companies and acquire the majority or hundred per cent (100%) shareholdings or stakes of the company. They take outright ownership and control of the company. Private Equity Firms will eventually sell the company once it has performed reasonably.
Incubators and accelerators
Startup incubators and accelerators aim to help startups grow their businesses. They can be sources of funding and provide mentorships, resources, and networking opportunities. Usually, they take a certain percentage of ownership, around five to ten per cent, in return for their services and capital.
Tax Implications
The fundraising exercise requires the startups to dispose of their shares to investors in return for capital. The disposal of shares is subject to capital gain tax (“CGT”) under the Income Tax Act 1967. The rate of CGT is 10% of the chargeable income from the disposal of shares. Therefore, startups must bear in mind that the target amount to be achieved from the fundraising exercise is before the CGT deduction.
Legal Documentation Related to Cap Table
Proper legal documentation is important for startups because it protects the rights of all shareholders and stakeholders in the company as well as provides clarity and transparency in the company’s equity structure. Having proper legal documentation allows you to manage and keep your cap table updated. The following legal documents may be relevant for the purpose of fundraising:
Subscription Agreement;
Share Sale Agreement;
Shareholders’ Agreement;
Constitution or Memorandum and Article of Association; and
Term Sheet.
Common Challenges In Cap Table and How to Overcome Them
Complexity
A cap table may become complex as startups grow and have multiple rounds of funding. There will be more shareholders, investors, and equity instruments, each with different terms and preferences. It can be challenging to keep track of all the details and to analyse how they affect the company's ownership and value.
At this stage, startups may need more sophisticated and secure software that can manage the complexity of multiple rounds of funding, convertible notes, preferred shares, dilution, valuation, and exit scenarios. This software has great features that could help you automate calculations, generate reports, track ownership history and share with stakeholders.
Dilution
Dilution happens when new shares are issued, resulting in a reduction of existing shareholders’ ownership percentages. This will impact the value of existing shares because the total value of the company is now divided among a greater number of shareholders, which affects the return on investment for shareholders.
Therefore, startups must consider mechanisms to minimise dilution and protect the interests of existing shareholders. One way is to negotiate favourable terms with investors to obtain a fair valuation and a reasonable dilution rate. Startups also need to manage vesting and exercise schedules to align with their goals and milestones and incentivise existing shareholders to stay and contribute to the company. Startups also may create a reasonable option pool that reflects the market standards and the value of their team. An option pool consists of shares of stock reserved for employees. It is a mechanism to attract talented employees to a startup company at the expense of dilution. Despite that, it is a considered factor by investors when they want to invest in startups. Investors, especially venture capital funds, look at the equity held by active employees, including founders, because the investors want the active employees to be fully involved in the company.
Valuation
Factors that affect a company's valuation include market potential, revenue projections, intellectual property, competitive landscape, and team expertise. Startups may face difficulties in determining valuations at each stage as the factors change.
Startups and their team must review the analysts that conduct their company valuations, their level of experience and the methods that have been used to conduct the valuations. It is crucial for startups to hire competent valuation analysts who can provide high-quality valuation modelling based on the position of startups. These are some valuation methods applied in Malaysia:
Fair value
Fair value is the value of the share or security agreed upon by the company and the purchaser. It involves finding out the company’s total net asset value minus its liabilities. The net asset value can generally be found in the shareholders’ agreement.
Cost price
This approach presumes that the value of the business is the value of its accumulated tangible assets. The calculation is similar to the fair value method above.
Discounted cash flow (DCF)
Using this method, a company's valuation can be obtained by evaluating its value based on its projected cash flow.
Comparable
The valuation is determined by comparing it with other companies of similar businesses and sizes. The P/E multiplier is used for this calculation.
Growth Management
As a startup grows, its cap table becomes more complex and requires careful management to ensure that the evolving equity structure is reflected. The biggest issue faced by startups will be the declining ownership position of the founders and team after the seed round. Another issue that startups might deal with is dead equity. Dead equity refers to shareholders who no longer contribute to the equity and are no longer actively involved in the company's success.
In each new funding round, startups must adjust the cap table by reflecting new funding rounds. Startups must update the cap table to include new shares issued, the amount raised and the terms of the investment. This will show pre-money and post-money valuation and the effect of new investment towards the ownership percentages of existing shareholders. The startup also must update the cap table to include new stock options granted to employees. Potential dilution that impacts the existing shareholders must be communicated to them. Next, convertible notes and SAFEs (Simple Agreements for Future Equity) are often used in early-stage fundraising. These instruments convert into equity at later stages, impacting the cap table. So, startups must carefully consider the conversion terms and conditions. Upon conversion, startups must update the cap table to reflect the new equity ownership, ensuring that all changes are transparent and adhere to what has been agreed upon.
Compliance, Strategic Plan & Documentation
Startups tend to neglect legal documentation, including agreements and statutory requirements, such as statutory forms that need to be submitted to the relevant authorities. Startups must avoid any legal hiccups that could potentially destroy the company's goodwill. Investors will avoid investing in a company that facing serious legal actions.
It is important for startups to get proper advice and guidance at the early stage from a corporate lawyer. A corporate lawyer will strategize and advise on the startups' fundraising plans and compliance. This is to ensure that the cap table is clean and not tainted by issues. Although it is not impossible to repair a broken cap table, it is a difficult process that will cost startups later. A corporate lawyer will help startups adhere to cap table best practices. The objective is to strike a fair balance between the potential upside that founders and management shareholders can receive at an exit and what investors can earn on their investment. Hiring a corporate lawyer can be beneficial for startups as the lawyer will provide proper legal documentation to ensure that startups comply with the legal requirements. A corporate lawyer may also introduce startups to the fundraising ecosystem.
Conclusion
In conclusion, understanding and managing cap tables is crucial for Malaysian startups aiming to secure equity funding and achieve sustainable growth. A well-maintained cap table provides clarity in ownership, facilitates transparent communication with stakeholders, and supports strategic decision-making. By effectively creating the cap table, startups can navigate the complexities of equity management. Proper legal documentation and valuation practices further enhance the integrity of the cap table, making it a powerful tool for attracting investors and fostering long-term success. Having a clean cap table helps Malaysian startups prevent early-stage mistakes, build investor confidence, and lay a solid foundation for future expansion.
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