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Cap Table Basics: Making Room For New Stockholders

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For an investor-backed, high-growth company, issuing stock, to existing and new stockholders, will be a regular occurrence. Raising money through equity financings is the primary time stock is issued, but companies will also issue stock (or stock options) to employees, consultants and others who contribute value to the company.

For companies going through a financing or stock issuance for the first time, the impact of a stock issuance on the company’s capital structure can be confusing. This can be particularly true if you have had experience with partnerships, LLCs or other entity forms that handle ownership differently than corporations.

A common misconception is that when a new stockholder is added, the ownership allocated to that stockholder comes from the existing stockholders. If a company issued 900,000 shares at its organization, for example, it is assumed that a new stockholder receiving a 10% interest should receive 90,000 shares (10% of the total), to be transferred from the shares originally issued to the existing stockholders.

In reality, shares are not transferred from existing stockholders. To add a new stockholder, the company simply issues new shares to the new stockholder. As a result, the total number of shares increases. To continue the previous example, the new stockholder would be issued 100,000 shares, and the total number of shares would grow from 900,000 to 1 million.

As a result of the new shares, the existing stockholders’ percentage ownership is diluted, proportional to the number of shares held by each stockholder.

Understanding, modeling and maintaining a capitalization table is a critical aspect of managing a high-growth, investor backed company. Proper maintenance requires careful planning and attention to procedures and laws, and a relatively simple oversight has financial implications. 

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Having outside counsel manage your cap table allows you to make decisions based on information you can rely on. If you have further questions regarding capitalization tables or are ready to hire outside counsel, contact Inceptiv Law.

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