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A Capitalization Table gives a comprehensive picture of the financial position of a business at the end of the year. It shows the amount of money needed to operate a business and its ability to pay its debts. In essence, a Capitalization Table shows how much money a business can raise from a third party source, i.e., investors, for the year to finish. A Capitalization Table provides a tool for funding analysis and allows business owners and managers to make informed decision about their financing needs.

The basic component of capitalization tables is the balance sheet that shows current and long-term differences between assets and liabilities. The balance sheet should show a consistent and reliable income from various sources and the accuracy of this data should be within reasonable range. One way to evaluate the reliability of the balance sheet is to compare it to the actual value of the company’s capital during the year. The purpose of a cap table is to provide a means for comparing the effectiveness of capital budgeting at the end of the year relative to the start of the year.

The second factor to consider is the effect of dividends and capital gains on a business’s net worth. Capital gains and dividends have two effects that can collectively be termed as the Cap-and-Gain Rule. First, they reduce the net worth of the company; second, they increase the net worth of the owner (the investor). Dividends yield exactly zero percent per share; capital gains yield one percent per share.

The third factor to evaluate is the net effect of equity compensation and capital budgeting. Equity compensation decreases cash flow and increases the cost of capital for startup entrepreneurs. In addition, equity compensation increases potential risk to the company in the form of higher retained earnings and higher debt. Therefore, the effect of equity compensation and cap table calculation on startup entrepreneurs is to reduce cash flow, increase costs of capital, decrease startup financing, and reduce equity valuation.

The fourth factor to evaluate is due diligence. Due diligence is the process of investigating, evaluating, documenting, overseeing, and otherwise overseeing the hiring and managing of employees. Each employee is a unique contributing element to the success of the business. Therefore, we must take into consideration the extent and frequency of each individual’s contribution to the company’s success. The size and longevity of an organization’s key employees can have a profound impact on its performance and business future. Likewise, the quality and size of the people who work with startup entrepreneurs will have a major impact on the organization’s revenue and growth.

Finally, startups that fail to appropriately tap into capital through capitalization and venture capitalization miss an important opportunity to become the “fast track” to growth. In essence, the inability of startups to successfully raise capital and utilize venture capital drives many companies into a position where they are unable to generate the proceeds from sales to pay for the costs of capital and startup operations. While it may not seem like much of a problem at first, the inability to pay for these costs leads to one of two situations: first, inherently imbalanced employee ownership shares; second, inherently imbalanced ownership of the company’s equity. Both of these problems lead to the organization becoming financially unstable and vulnerable to failure.

Fundamentally, startups need capital to create and grow businesses that can provide long term value to investors. However, when companies fail to properly raise capital and tap into multiple sources of venture capital, they become financially unstable. In this unstable environment, the inability to attract investors and the lack of capital funding drive startup owners to solve the financial problems by selling their businesses to outside investors. This sale of startup businesses often results in one of two things: either (i) the selling of all or (ii) all but one or two of the startups fail, leaving the remaining startup with insufficient capital to continue operating. Alternatively, some startups attempt to resolve their problems by taking their businesses to bankruptcy and, if they fail, having to reinvent themselves in an attempt to save themselves.

The current state of affairs with many startup businesses is what is known as a capital table environment. A capital table is where a company’s cap or EBIT (earnings before interest and tax) is split between different investors in the capital structure. Typically, the only people who benefit from a capital table are the initial investors, although these investors typically do not receive high percentages of the EBIT as a result of their investment. For example, in a convertible preferred stock financing scenario, where the convertible preferred stock is financed via a cap table, the rate of return on the preferred stock will be dependent on the price and book value of the preferred stock.