fredlaw - surge: know your cap table for startups

Discussion Leaders • Patrick Donohue

Financial Strategist President, Hill Capital Corporation

• Eric Madson Shareholder Fredrikson & Byron, P.A.

• Kevin Spreng Shareholder Fredrikson & Byron, P.A.

© 2015 Fredrikson & Byron, P.A.

Notes of caution • This presentation is about the capitalization structures of

corporations. It does not specifically address the capitalization of LLCs or other entities.

• Corporations are governed by the laws of the state in which they are incorporated and the laws of each state are different, so while some statements in this presentation may be true for some or most corporations, they are not necessarily true for all corporations.

• The statements in this presentation are general in nature but there are almost always exceptions to the rules.

• References to “Charter” means either the corporation’s Articles of Incorporation (MN) or Certificate of Incorporation (DE).


What is stock? • A share represents a fractional ownership interest in a

company.

• Shares can be different classes (common or preferred) and series (e.g., Series A Preferred Stock, Series B Preferred Stock, etc.).

• Each series is a sub-set of a class (e.g., Series A Preferred Stock is part of the Preferred Stock class).

• In addition, companies often issue options, warrants and convertible promissory notes.


How many shares should a company have?

• Typical for a tech start up to have 10,000,000 shares of common stock to start.

• Be aware that in Delaware the number of shares will impact the amount of annual franchise tax the company is required to pay.

• Object is to have enough shares to issue to founders, other service providers and initial investors.

• The fewer number of shares you have authorized the greater the minimum percentage of the company that you can grant or issue. For example if you have 100 shares authorized the smallest percentage you can grant would be 1% (i.e., one share).


How are shares created?

• Shares are created in a company’s Charter. See sample.

• Initially this is done by the incorporator in the initial filing but after shares are issued changing the number of authorized shares requires approval of the board of directors and/or shareholders.


What type of shares are there?

• Generally

• Common Stock and Preferred Stock • Voting and Non-Voting

• Many nuances, particularly with respect to Preferred Stock. Common variations relate to:

• Liquidation preference

• Participation after preference • Dividends

• Redemption

• Voting rights, protective provisions • Anti-dilution protection


How does a company create dif ferent classes and series of shares?

• If the company’s charter includes what is know as “blank check” authority, the board of directors may by resolution create a new class or series of stock.

• If the company does not have blank check authority, creating a new class or series is done by amendment of the company’s charter which requires approval of the board and shareholders.


How are the terms of shares changed? • Before any shares of the series have been issued:

– By the Board, if it originally created the series with “blank check” authority.

– By the Board, with approval of the shareholders, if the Board did not have “blank check” authority.

• After shares of the series have been issued: – By the Board, with approval of the shareholders.

– Approval may require a vote of holders of the series, voting separately as a class, if the Charter or the governing state law requires a class vote.

• MN: If the amendment would “change the rights or preferences of the shares of the class or series.”

• DE: If the amendment would “alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely.”

• Dissenter’s rights may apply under some state laws.


What is the dif ference between authorized shares and outstanding shares?

• The number of “authorized” shares of any class or series or in aggregate is the number provided for in the company’s Charter. See sample.

• “Outstanding” shares are shares that have been issued by the company and not redeemed, repurchased, exchanged or cancelled.

• The number of shares issued is not necessarily the same as the shares outstanding as the company may have redeemed some of the issued shares (“treasury stock”) or taken other action that reduces the shares outstanding.


How are shares “ issued” ?

• The company’s board of directors must approve all issuances of securities.

• Typically, issued shares would be evidenced by a stock certificate signed by one or more officers of the company.

• Whether or not the company’s shares are certificated, the company will make an entry in its stock records reflecting the name of the shareholder, number of shares issued and the date of issuance.


How many shares should each founder have?

• Difficult question; it depends on relative value and fairness.

• Considerations include contribution to the founding business idea and related IP, anticipated contribution to the company in the future, capital invested, and ability to raise capital.

• See http://foundrs.com/ • Of the authorized shares founders generally initially hold

50% to 80%.


Should Founders’ shares vest?

• Yes, vesting protects other founders and equity holders from what is know as “free-riding,” that is a founder receives a significant percentage of the company and does not do his fair share of the work going forward.

• Founders’ shares are at least in part in exchange for services and support in the future.

• Investors will generally insist on founder vesting, particularly in the early years of a company’s existence.

• Often replacing a founder that has left the company for any reason (good or bad) requires issuance of equity to his or her successor.


Should a company have an “ option pool ” ?

• “Option pool” refers to the shares that are reserved for grants or have been granted pursuant to equity incentive plans.

• Most startups have option pools that are used for grants to service providers (i.e., employees, contractors, directors).

• The option pool is typically between 10% and 25% of the fully-diluted capitalization of the company.

• Investors will expect an option pool and generally will require that it be included in calculating the pre-money per share price.

• Shares reserved in an option pool are most often used to grant service providers restricted stock, incentive stock options (ISO), and non-qualified stock options (NQSO).


How does a company create an option pool?

• An option pool is created when the company adopts an equity incentive plan.

• The authorizing resolutions include (directly or by reference) the number of shares available for issuance under the plan and reserve these shares from the company’s authorized shares for issuance under the plan.

• The number of shares authorized under the plan (and all other plans) will be the “option pool.”

• Within the option pool there are “available shares” and “unavailable shares” (or similar designations).

• Available shares are the number of shares reserved for issuance under the plan minus the number of shares covered by outstanding options or that have been issued.


What “ stock records” should a corporation have?

• Cap Table (summary of authorized and issued shares) • Stock Ledger (chronological record of shares issued or

transferred)

– Separate stock ledger for each class and series of stock

• Option Ledger (chronological record of options granted, exercised, or terminated, including vesting schedules)

• Shareholder List (who are the shareholders and how many shares or options do they hold at a specified date)

• Shareholder addresses and contact information


Why is it important to keep good stock records?

• Who owns the corporation

• Who is entitled to vote as a shareholder

• Exit transaction – who gets paid, and how much • Exit /financing transaction – due diligence

• Exit / financing transaction – support for legal opinions

• Shareholder inquiries – how much did I invest?


What does a cap table look l ike?

ABC, Inc.CAPITALIZATION SUMMARY

December 31, 2014

No. of Shares Outstanding Fully Diluted

Shares No. of Shs % of Cmn Stk % ofAuthorized Outstanding Shs O/ S Equivalents F/ D Shs

COMMON STOCK 15,000,000 Common Stock issued and outstanding 6,000,000 51.7% 6,000,000 43.3%Stock Option Plan - options outstanding (common) - 0.0% 1,300,000 9.4%Stock Option Plan - shares available for additional options - 0.0% 950,000 6.9%Warrants for Common Stock - 0.0% - 0.0%

SUBTOTAL - COMMON STOCK 6,000,000 51.7% 8,250,000 59.6%

PREFERRED STOCKSeries A Convertible Preferred Stock 2,250,000 2,200,000 19.0% 2,200,000 15.9%Series B Convertible Preferred Stock 3,500,000 3,400,000 29.3% 3,400,000 24.5%

TOTAL 20,750,000 11,600,000 100.0% 13,850,000 100.0%

Class and Series of Stock


What does ful l y diluted mean? • Total number of shares of common stock outstanding,

plus all shares of common stock issuable upon exercise or conversion of outstanding options, warrants, preferred stock, and other securities.

• In the case of calculating price per share fully diluted generally also includes all shares authorized for issuance under all equity incentive plans. See below.


How is a per share valuation calculated?

• Pre-money value of company divided by “fully-diluted” number of shares.

SURGE, Inc.

Pre-Money CapitalizationStockholders FD %

Common Stock Series A Fully DilutedFounder 1 4,000,000 - 4,000,000 34.50%Founder 2 2,500,000 - 2,500,000 21.56%Founder 3 1,500,000 - 1,500,000 12.94%Stock Options Issued 500,000 - 500,000 4.31%Stock Option Available for Grant 500,000 - 500,000 4.31%Option Pool Increase 2,595,000 - 2,595,000 22.38%Total Issued Shares 11,595,000 - 11,595,000 100.00%

Series A Financing Details Pre Money value 3,000,000Price Per Shares 0.2587New Money 1,000,000New Shares 3,865,000

Post-Money CapitalizationStockholders FD %

Common Stock Series A Fully DilutedFounder 1 4,000,000 - 4,000,000 25.873%Founder 2 2,500,000 - 2,500,000 16.171%Founder 3 1,500,000 - 1,500,000 9.702%Stock Options Issued 500,000 - 500,000 3.234%Stock Option Available for Grant 500,000 - 500,000 3.234%Option Pool Increase 2,595,000 - 2,595,000 16.785%New Investors (Series A) - 3,865,000 3,865,000 25.000%Total Issued Shares 11,595,000 3,865,000 15,460,000 100%

Shares

Shares


Resources

• http://avc.com/ • http://www.feld.com/


Samples

• NVCA form of Certificate of Incorporation


Contact Information

Eric Madson Fredrikson & Byron, P.A. [email protected] 612-492-7394

Kevin Spreng Fredrikson & Byron, P.A. [email protected] 612-492-7395

Patrick Donohue Hill Capital Corporation


fredlaw - surge: know your cap table for startups

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