trica equity’s Cap Table Dictionary

trica equity‘s cap table dictionary comprehensively enlists all the important terms pertaining to cap table management. Must read for founders, employees, and investors!

Note: We have called this a dictionary but not organized it alphabetically intentionally! We’ve tried to capture the flow of events, and we believe this will help you understand Cap Tables better!

Cap Table: It is a table that provides an overview of the ownership (shareholding) of the company. It typically provides details of the shareholding of various stakeholders (founders, investors, advisors, employees), e.g. type of security (e.g. equity, SeriesA-CCPS, SeriesB-CCPS, etc.), number of shares, % shareholding, etc.

Equity – This is the most basic form of security/shares in a company, also called common stock in the US. These are less preferred by investors than CCPS because the CCPS holders have a higher liquidation preference than Equity holders in case of a liquidity event.

CCPS: This is the most common instrument used by Startups in India. These are basically preference shares (also called preferred stock in the US) that give the investors a preference over Equity Shares. Typically preference shares have a higher liquidation preference meaning the preferred stockholders get their money back first if they must be liquidated. CCPS may also carry a fixed dividend, but most Startups keep it very low, say 0.0001% per annum. The CCPS must compulsorily convert into equity shares within 20 years after issuance.

Convertible Debt: Convertible debt is when a company borrows money from an investor to convert the debt to equity at some later date. Typically, how the debt will be converted into equity is specified at the time of investment. In India, two kinds of convertible debt instruments are most common in Startups – CCD (compulsorily convertible debentures) and Convertible Note (only for DPIIT recognized startups).

CCD: This is a debt instrument that has to convert into shares compulsorily. This is mostly used to defer valuation discussions and can be tied to future financing. The key terms of the investment include a Valuation cap – beyond which the investors’ shares cannot be valued at the time of conversion, Discount – which is a % discount to the next round valuation, Interest rate of the CCD – which can be a bare minimum number. Read more.

Convertible Note: This has been allowed recently in India but only for DPIIT recognized Startups. A convertible note is an optionally convertible instrument giving investors the option to convert their investment into equity at a predetermined discount to the next round of funding. If the Startup’s valuation does not increase as per the investor’s expectation, the investor can choose not to convert and instead redeem the notes at an interest rate subject to the terms & conditions contained in the Convertible Note agreement. This reduces the risk for the investor while allowing the possibility of conversion into equity if the startup performs well.

Fully Diluted Cap Table: This version of the cap table shows the total current outstanding shares assuming that all options, warrants, or other convertible securities etc., have been exercised or converted in full. For example, your entire ESOP pool is added, and all CCPS/CCD shares get converted into Equity shares for the fully diluted cap table.

ESOP Pool: An option pool consists of stock reserved for employees of a private company. Equity grants depend on the size of the employee stock option pool (ESOP Pool).

Seed Capital: The funding required to get a new business started. This initial funding usually comes from the business owner(s) and perhaps friends and family or angel investors.

Series A, Series B, etc.: These are usually institutional rounds of funding that the startup raises from VC funds. During each round of funding, a separate class of preferred shares usually gets issued, which has a higher preference over all previous shares, e.g. Series B CCPS may have higher preference over Series A CCPS shares.

Lead Investor: Lead investors lead a funding round. Groups leading a funding round often appoint an individual who, while not necessarily the one investing the most money, can contribute the most to the company in terms of time and experience. Lead Investors willingly step in and don the mantle of the captain of the investor syndicate. These investors would have ideally engaged with the startup before understanding the business and seeing how he can support the entrepreneur.

Syndicate: A syndicate is an investment vehicle that allows investors to co-invest with lead investors in startups.

Pre-money Valuation: It refers to the market value of a startup before an investment or financing round.

Post-money Valuation: It refers to the market value given to a startup after a round of financing from angel investors or venture capitalists (VCs) has been completed. Post-money valuation = pre-money valuation + funds raised

Term Sheet: This is the first formal — but non-binding — document between a startup and an investor. A term sheet lays out the terms and conditions for investment. It is used to negotiate the final terms, which are then written up in a Shareholders Agreement (SHA).

DD (Due Diligence): Once the term sheet is signed, investors generally start due diligence. Due diligence is basically an investigation or comprehensive appraisal of a startup conducted before the startup enters into a contract with an investor. This process has many aspects – legal, financial, compliance, or business – depending on what the potential investor deems fit.

Shareholder Agreement (SHA): SHA is nothing but an elaborate form of what is agreed on the term sheet. It is an agreement entered between the company and its shareholders describing their rights and obligations. Some of the key provisions in the SHA include ROFR, liquidation preference, anti-dilution clause, drag-along, tag-along, cap table (shareholding details), Board composition, pro-rata, founder lock-in, ESOP pool, reserved matters, etc.

CP and CS (Condition Precedent and Condition Subsequent): After all parties sign the SHA, CP & CS are outlined and completed by the promoters of the startup. A CP is a legal term that describes a set of conditions that must be fulfilled before the contract between the startup and its investors is considered to be in effect. On the other hand, a CS is a legal term that represents a set of conditions that must be completed by the company post.

Board Seat (Director) & Board Observer: Investors generally look for a board seat and/or a board observer seat in the startup they invest in. A board seat allows the investor to have a voting right in all board meetings of the startup. The board observer seat allows the investor to attend board meetings only – the observer can evaluate the meeting proceedings but has no voting right in board matters.

Affirmative Voting Rights (veto rights): Investors become minority shareholders in the startup after investing their money. They, therefore, look for affirmative voting rights or veto rights. These rights allow the investor to exercise their authority to approve a list of matters that have a critical monetary impact on the company. The investor will thus have to block a matter, though he can’t pass a matter unilaterally.

Liquidation Preference: Liquidation preference is a clause in SHA that dictates the payout order in a liquidation event (e.g. M & M&A). Typically, the company’s investors or preferred shareholders get their money back first, ahead of other shareholders.

• Non-participating liquidation preference: In this method, the investor will receive an amount equal to his initial investment. Any surplus amount will be distributed among the rest of the shareholders.
• Participating liquidation preference: First, the investor will receive an amount equal to the initial investment. Then the remaining amount will be divided in proportion to the shareholding percentages from which this investor will also get his share of the proceeds.
• Liquidation preference multiple: If it is a 2x non-participatory liquidation preference, the investor will receive twice his investment amount, that’s all. But if it is a 2x participatory liquidation preference, he will also receive a share of the proceeds when the remaining amount is divided among the shareholders.

Anti-dilution Provision: This is a clause in the SHA which gets triggered when a Startup goes through a down-round, i.e. it raises money at a share price lower than what the investor had paid in the last round. There are two commonly used forms of the anti-dilution clause.

• Full ratchet anti-dilution provision: In this method, the price for existing investors is revised to that of the new round. Thus existing investors get additional shares based on their investment amount and the new share price. The full ratchet method of anti-dilution protection is very harsh on the Company and the Founders compared to the broad-based weighted average method.
• Broad-based weighted average provision: This method uses a weighted average formula that considers the number of shares issued in a subsequent round of investment and the number of shares held by the existing investors.

ROFR: Right of First Refusal is a provision in the term sheet or SHA that permits existing investors to accept (or refuse) the purchase of equity shares offered by another shareholder before they are sold to a third party.

Tag-Along Rights: Tag-Along Rights or TARs say that if the majority shareholder of an entity sells their stake, the remaining minority shareholders have the right to join the deal and sell their shares at the same terms and conditions as the majority shareholder. The new owner must purchase those shares as well.

Drag-Along Rights: A drag-along right is a provision that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.

Founder Vesting: Founder vesting is a concept through which a founder’s total shareholding in the company is agreed to in the present, but it is earned over time, similar to how an ESOP vesting happens. If a founder leaves a company, the unearned portion of their shares is cancelled or returned to the company.

Liquidation Event: A liquidation event is a typical exit event of a startup in which shareholders may get cash for their shares. Such events can be mergers & acquisitions (M&A), purchase or sale of the company, or an Initial Public Offering (IPO).

Acqui-hire: Acqui-hire is the process of acquiring a company primarily to recruit its employees rather than to gain control of its products or services.

Accelerated Vesting: This allows a company to quicken the vesting schedule for an employee or founder vesting. Accelerated vesting generally occurs at the time of mergers & acquisitions.

Share Split: Share Split is basically an event where the startup divides its existing shares into multiple shares to boost the liquidity of shares. It causes a decrease in the share price of individual shares but does not change the valuation of the company.

Compliance-related Cap Table Terminologies

MoA: MoA or Memorandum of Association is a legal document prepared while forming & registering the Company and needs to be filed with ROC. This document describes the charter/constitution of the company, e.g. name, registered address, business objectives, rights, liabilities, capital, etc. Any changes to the MoA, later on, can only be done via a special resolution of shareholders.

AoA: AoA or Articles of Association is a legal document that specifies the regulations/bye-laws for its operations. It has various clauses regarding allotment of shares, rights of shareholders, accounting and audit policy, the functioning of the board of directors, etc.

Share certificate: Issued by a company, a share certificate certifies that a certain person becomes the registered owner of shares in the company on the issue date. The certificate generally holds the name & address of the shareholder and the number of shares held. Share certificates are deemed valid when 2 directors sign them.

Stamp Duty on Share Certificate: The stamp duty on the share certificate in India depends on the state in which the company is registered. In many states, the stamp duty on shares is INR 1 for every INR 1000. Every company is required to pay stamp duty on the value of shares within a period of 30 days from the date of the issue of share certificates.

Digital Share Certificate: Shares issued without physical paper stock certificates are called digital or electronic shares. These certificates are signed through DSCs. A Digital Signature Certificate (DSC) is a secure digital key issued by the certifying authorities to validate and verify the identity of the person holding digital signature certificates.

Demat Shares: Demat Shares or Dematerialized Shares are shares that can be registered & transferred electronically. Through dematerialization, so-called DEMAT accounts allow for electronic transactions when shares of stock are bought and sold. Within a DEMAT account, the certificates for stocks and other securities of the user are held as a means for seamless trades to be made. These shares save 0.25% stamp duty on share transfer and 0.1% (most states) stamp duty on fresh share allotments. In India, only CDSL and NSDL (also called depository) can hold DEMAT accounts.

• ISIN: International Securities Identification Number or ISIN is a code that uniquely identifies a specific securities issue. An ISIN needs to be created by a company before DEMAT shares can be allotted.
• DP: A DP (Depository Participant) is a SEBI certified company that acts as an intermediary between the depository (CDSL/NSDL) and the investors. As an investor, you must open a Demat account through a DP first. Most banks and some broking firms are registered as DP with the SEBI.
• DRF: Dematerialization Request Form or DRF is a form that is required to be filled and submitted by the investor to the DP to convert their physical securities into electronic form. Upon submission of the DRF and physical certificates, the application is processed by the DP. Also, physical share certificates are submitted to the registrar of the issuer company. The registrar, in the next step, confirms the dematerialization request.

Taxation on Share Allotment:

• There is no income tax if the shares are allotted to the shareholder at the FMV (fair market value obtained from a certified valuer).
• The shareholder who acquires shares below the FMV must pay income tax as a normal income on the difference between the FMV and the purchase price.
• A company that allots shares at a price above FMV must pay tax on the difference between the allotment price and the FMV.

Taxation on share transfer: Profit or gain arising on transfer of shares is considered as an investment by the assessee and is chargeable to tax under capital gains

• Long-term capital gains on the sale of unlisted equity shares: The assessee does NOT have an option to pay tax at the rate of 10% like publicly traded stocks. They will have to pay a tax of 20% (with indexation benefit)since the shares are for an unlisted company.
• Short-term capital gain on sale of unlisted equity shares: The assessee will have to pay the tax as per their applicable income tax slab rate

SH-4: SH-4 or Securities Transfer Form is for the consideration that the owner of the securities wants to transfer the said securities to the new owners of those securities. Both the involved parties willingly accept the underlying conditions of transfer in the form of a declaration.

PAS-3 Form: Whenever any startup makes any allotment of shares or securities, it must file a return of allotment in e-Form PAS-3 on the ROC Portal within 15 days of allotment. The filing should include the complete list of allottees to whom the securities have been issued, CIN, and all details & conditions about the allotment.

PAS-4 Form: This is a form for a Private Placement Offer cum Application Letter and needs to be filed on the ROC portal every time an investor is offered shares via the private placement route (which is the most common way).

PAS-5 Form: This is the form that is used to record all the private placement offers (in the form of PAS-4) made by the company for internal purposes.

MGT-14: This is filed with ROC for every board and or shareholders (AGM/EGM) resolutions.

MGT-9 Form: MGT-9, also called “extract of annual return”, is a report which has to be furnished along with the director’s report as part of the company’s annual return. It contains many details about the shareholding pattern of the company, e.g. Indian vs foreign shareholding, individual vs institutional shareholding, etc. There are details about the director’s remuneration also in this report. Note that this requirement is prescribed as per the companies act 2013.

FIRC: FIRC or Foreign Inward Remittance Certificate is a document issued by the receiving bank as evidence that the startup received money from outside India in foreign currency. FIRC is required as per RBI & FEMA regulations.

FCGPR: FC-GPR or Foreign Currency- General Permission Return is a form that ought to be filed on the RBI website by a company when it receives a foreign investment and allots shares to the foreign investor in return. FCGPR needs to be filed within 30 days of shares allotment. After filing FCGPR, RBI issues a UIN number, and it is essential at the time of exit when money needs to be repatriated by the investor back to the foreign country.

AGM & EGM: An Annual General Meeting (AGM) is a general shareholder meeting held by the company every year to discuss various business matters. An Extraordinary General Meeting (EGM) is any shareholder meeting other than the AGM; it needs to be called for with 21 days prior notice unless a short notice consent is already obtained from 95% of shareholders.

Ordinary Resolution & Special Resolution: Ordinary Resolution is a resolution wherein a simple majority (51% of the members present and voting at the AGM/EGM) must pass the resolution. Special Resolution is a resolution in which a supermajority(75% members present and voting at the AGM/EGM) is needed to pass the resolution at the general shareholder meetings.

Valuation Certificate: A valuation certificate is required to ascertain the FMV (fair market value) of shares of a company. Under the Companies Act 2013, a Valuation certificate is required when the company does the issuance of shares. This certificate can be procured from a registered valuer or merchant banker.

Registered Valuer: A registered valuer is an individual or organization that carries out the valuation process with respect to assets, stocks, shares, debentures, securities, or goodwill or net worth of a company and/or its liabilities. They are typically CA (chartered accountants) who are registered with IBBI as a Registered Valuer.

Merchant Banker: As per SEBI rules, a merchant banker is an individual who is engaged in the business of issue management either by making arrangements regarding buying, selling, or subscribing to securities or acting as manager, consultant, or rendering corporate advisory services in relation to such issue management. A SEBI registered merchant banker is authorized to provide a valuation certificate for a company, especially if required under the Income Tax Act.

Share Certificate in a joint name: When multiple individuals jointly own shares, the share certificate issued should include all the names of the joint shareholders. Each joint shareholder is a separate member of the company except in a private limited company, where the joint shareholders are treated as a single member. In private limited companies, the first-named joint shareholder will be treated as a member, and all correspondences or transactions will be done with them only.

DVR: DVR or Differential Voting Rights refers to equity shares holding differential rights as dividends and/or voting. This helps increase the founder’s voting rights to continue to maintain control of their company despite having small shareholding percentages. SEBI allowed a powerful DVR framework for startups in 2019.

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Disclaimer: This article has been prepared for general guidance on the subject matter and does not constitute professional advice. The matters described herein are general in nature and have not been evaluated based on applicable laws. You should not act upon the information contained in this note without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this note. LetsVenture Technologies Private Limited, its partners, employees, and agents accept no liability and disclaim all responsibility for the consequences of you or anyone else acting or refraining to act in reliance on the information contained in this publication or for any decision based on it. Without prior permission of LetsVenture Technologies Private Limited, this note may not be quoted in whole or in part or otherwise referred to any person or in any documents.