Cap Tables, Dilution, and Deal Terms
A deep dive on the equity itself: who owns what, who gets paid, and how ownership erodes round by round. The cap table as the founder’s financial constitution and why fully diluted is generally the fairest basis for comparison; equity classes and the liquidation stack; the three forms of liquidation preference and how they reshape every exit; SAFEs and convertible notes as the default pre-seed instruments; conversion mechanics and the hidden cost of liquidation-preference overhang; the option pool and the pre-money vs. post-money shuffle; the equity waterfall and how dilution compounds across rounds; and antidilution, term-sheet economics vs. control, vesting, and the 83(b) election, with five interactive calculators.
125 min
18
52
6
Learning Objectives
By the end of this chapter you should be able to:
- 1Read a capitalization table and explain why fully diluted ownership is the soundest basis for comparing offers.
- 2Distinguish common from preferred stock and order the liquidation stack from secured debt down to common.
- 3Compare nonparticipating, participating, and capped-participating preferred and show how each reshapes founder proceeds at an exit.
- 4Explain how SAFEs and convertible notes work as pre-seed instruments, and why the post-money SAFE fixes each investor's ownership at signing.
- 5Trace conversion mechanics and the liquidation-preference overhang that discounted or capped instruments create.
- 6Analyze the option pool and the pre-money versus post-money distinction, and compute investor and founder ownership after a priced round.
- 7Build an equity waterfall and show how founder dilution compounds across successive rounds.
- 8Compare full-ratchet and weighted-average antidilution and their effect on founder ownership in a down round.
- 9Read a term sheet as a package of economics and control terms, and explain vesting, acceleration, and the 83(b) election.
Part One: The Cap Table Is the Founder's Financial Constitution. Section 1 of 8.
Part One · The Cap Table Is the Founder's Financial Constitution
The Cap Table Is the Founder's Financial Constitution
The Cap Table Is the Founder's Financial Constitution
Every equity decision a founder makes, from issuing stock to hiring employees to raising capital, flows through one document: the capitalization table. The cap table is the ledger of ownership. It records who holds what, how many shares exist, and what percentage of the company each stakeholder controls. A founder who does not understand the cap table tends to make decisions that are difficult to reverse.
The Foundation
A corporation begins by authorizing a large number of shares, commonly 10 to 20 million, and issuing a subset to the founders. The distinction matters. Authorized shares are available to be issued later, while issued shares represent actual ownership, and only issued shares appear on the cap table.
Formula. Share price = equity value / fully diluted share count. Fully diluted shares include issued common, all outstanding options, the shares reserved in the option pool, and every share issuable on conversion of preferred stock, SAFEs, and notes.
Reading a cap table correctly requires recognizing that the fully diluted columns show the maximum potential dilution. Unvested options and ungranted pool shares are included even though they may never vest or be issued. The rightmost columns, fully diluted shares and fully diluted ownership, are the numbers that matter in a financing.
Check Your Understanding
Knowledge Check 1
Cap Tables & Dilution
A startup authorizes 10 million shares and issues 6 million to its founders. What does the cap table record as outstanding?
Knowledge Check 2
Cap Tables & Dilution
A company is worth $12 million in equity value and has 8 million fully diluted shares. What is the per-share price?
Define Fully Diluted Before Comparing Offers
The meaning of fully diluted varies with what is included. Issued common, preferred as-converted, vested and unvested options, the unallocated pool, warrants, SAFEs, and notes may each be treated differently. Investors sometimes use a fully diluted pre-money figure in a way that shifts dilution onto founders. When a term sheet arrives without a pro forma cap table, request one before continuing the conversation, because verbal descriptions of ownership percentages are often unreliable.