Capital Structure & Share Options


If there is one thing you have to be sure of,
it is how many shares you have issued or promised.

The Cap Table

Your company’s capitalisation table (“cap table”) is a vital part in assessing the number of shares to be issued as part of an investment. The cap table should accurately reflect all issued shares and share options, as well as all convertible loans, warrants, etc. It should always be kept up to date, and you should know it inside and out.

The outline of how money is distributed in the event of an exit (liquidation, acquisition, or otherwise) runs from your cap table and is called the “waterfall.” In a simple shareholding, e.g. there are 2 founders and a few option holders, this is very straightforward. However, as you take on external funding, there are likely to be new classes of shares issued with different priorities and rights to capital — you will find that your waterfall gets quite complicated very quickly.

Below is a sample waterfall, showing the distribution of proceeds at different valuations for ordinary shares, seed preference shares (1X preference) and Series A shares, which in this case have a capped participating preference.

Waterfall_Space Graph-1

It takes a lot of work to make something complex look so simple and there can be a lot of excel magic going on in the background to come up with a clear, informative graph. The very useful and free is a godsend; it helps you enter and keep track of your shares and share options, adjust and graphically represent any waterfall scenario. Go get it!

A recent and very useful LTSE article on cap tables and share options is here. (Note: some of the content about options is US-focused, but the article is a great starting point for any company.)

Alexander Jarvis has an excellent, very detailed, slideshare showing cap table movement from incorporation through Series B, including a downloadable excel template here. The excel template is necessarily complex because it addresses the distribution of proceeds through a number of different funding rounds. If serves your needs, there will be no need to get to that level of excel-mastery.

Ordinary Shares

The basic unit of share in a company is the Ordinary Share. Shares which carry additional rights, over and above those held by Ordinary Shares, are generally referred to as “Preference” or “Preferred” Shares. Ordinary Shares are generally entitled to vote at shareholder meetings and they are entitled to a distribution of profits, or exit proceeds, only after all Preference Shares have received their returns.

Shares that carry different rights are often issued as separate “classes” of share. The separation of shares into different classes makes it easier to list those different rights in the Articles of Association/Constitution. Share class rights flow with the share itself rather than with the shareholder, although shareholders may also be given additional rights by contract, usually in a shareholders’ agreement.

Ordinary Share Classes

Ordinary Shares themselves can be issued in different classes, carrying different rights. A notable example of this is in Facebook where the class-B “common stock” (US-speak for Ordinary Shares) carry 10 votes per share, as opposed to the class-A common stock, which carry 1 vote per share.

While this does not increase the economic returns of the class-B common stock, it gives those shareholders a significantly increased say in certain corporate actions, like selling the company. Mark Zuckerberg is a significant holder of class-B common stock in Facebook. That’s awesome for Mark Zuckerberg, but is not likely to be something any investor will agree to for the rest of us.

Par Value

When you first incorporate, shares are allocated a “par” or “nominal” value. This is a somewhat archaic term that, in theory, represents the initial price for which shares are subscribed (bought). However, the par value of a share bears no real relation to the market value of that share and thus is a notional value only.

It becomes important when you account for shares, with any amount paid above the par value being allocated to your “share premium account.” Par value is usually a very small amount, e.g. €1 or even €0.00001 each.



There is no fixed set of rights which must be included for a share to be regarded as a Preference Share, and those shares can carry any, or many, rights greater than those attached to Ordinary Shares.

Priority on Exit: The most common and basic right attached to Preference Shares is the right to choose to either have the funds invested, returned, or take the allotted percentage of the exit value. On its own, this right protects the preferred shareholder on the “downside.”

Example 1

An angel investor invests €1M in your company at a valuation of €3M and therefore owns 25% of the “post-money” valuation (the post-money valuation being the original value of €3M plus the additional investment of €1M = €4M). If the company is subsequently sold for €2M, she has a choice to either:

  • receive her €1M back first, before the remainder is distributed to ordinary shareholders; or
  • take 25% of the $2M valuation, or €500k

Obviously in the case above, the angel will take her original funds back. She will not be happy with this return (1X only), but at least she did not lose any money beyond the normal rate of return she would have gotten, had she invested in another company or lodged the money in a bank account.

Example 2

In the same scenario, if the company is sold for €8m, the angel has the choice to either:

  • receive her €1M back first, before the remainder is distributed to ordinary shareholders; or
  • take 25% of the €8M valuation, or €2M

In the above case, the angel will choose to take her percentage, rather than the mere return of funds invested.

Share Option Summary

A Share Option is a right to purchase a share in a company at an agreed price, called the exercise price. If the company is successful and the shares are subsequently sold for a price greater than the original exercise price, the option holder will make a profit.

Share options are attractive to companies because:

  • they are a way to reward employees without spending the company’s cash; and
  • they motivate employees to work hard for, and to stay at, the company, because the employees themselves have a stake in the company’s success

At startup stage, you should be aware of the following general information/guidelines:

  • your company’s cap table is a vital part in assessing the price per share at which an investor is willing to invest; it should accurately reflect all issued shares and share options (in addition to convertible debt/warrants etc.) 
  • share options are usually granted over new (to be issued) shares; people are not generally given the option to purchase existing shares (e.g. from a founder)
  • share options are almost always granted over ordinary shares, not preference shares
  • share option pools can start as low as 5% of total share capital but can increase over time to 20%-25% of total share capital (25% is unusual)
  • share option pools can, and usually will, grow over time, in both percentage and absolute terms
    • a new investment may require that an option pool be increased from 5% to 10% because the new investor wants employees to have an incentive to increase shareholder value; such an increase in the pool usually dilutes the existing shareholders, not the new investor
  • share options get diluted along with other ordinary shareholders as you take on funding
    • do not guarantee that anyone will be “made whole” after future investment rounds
  • roughly map out your pool to allow for options to be granted on the commencement of employment and continuing option grants, which can be performance-based
  • a share option grant of 1%-2% is a significant amount; with a 15% pool, you would only be able to grant 15 people 1% share options. Only senior executives who can truly bring value at a global level should generally be considered for this size of grant. There are obviously some exceptions to this, such as if you need to bring in a new CEO.
    • Docracy’s Founder Adviser Template contains good guidance of the appropriate numbers of share options to be granted to advisers, depending on what value they can bring and the stage of the company.
  • before you formally issue share options, you should make sure that either (i) your constitution is changed so that the company can grant share options without the permission of shareholders (usually up to a certain number) or (ii) your shareholders have signed waivers of their pre-emption rights before you issue the options
  • always put any formal offer to grant share options in writing/email and do not verbally agree to grant share options without following up in writing
  • keep records of all offers of share options and include those numbers in your cap table
  • if you offer share options, let the option holder know, in writing, that, even if you don’t have a formal Share Option Scheme yet, any options granted will ultimately be subject to that scheme

How to Allocate Options

Many people talk in percentage terms when talking about share options. While percentages are fine to use as a general description, make sure to put a fixed number of shares against this percentage when discussing in writing.


    • for example, you could initially promise 0.5% of the company to a new adviser — let’s say that equates to 5 shares at the time. If time passes before you formalise the arrangement, you could have done another funding round in the meantime, and another 1000 shares could have been issued. After that funding round, 0.5% could equate to 10 shares. But you meant to grant the adviser 0.5% of the company at the time of the initial conversation, 5 shares. If you haven’t clarified it, you could easily end up in a disagreement with your adviser. 
    • the best way to talk about options therefore is to also mention a fixed number; e.g. “We’re delighted that you are coming on board as an adviser. As part of your package, we will grant you options to purchase 5 shares in our company, which, as of today, equates to 0.5% of our issued share capital. We don’t have a formal option scheme just yet but, when we do, the terms of the scheme will cover all share options, including yours.

Avoid talking about share options in terms of value, e.g. “we’ll grant you €30,000-worth of share options.” People generally talk in these terms when they allocate a “value” to the shares the same as the price per share at which an investor last bought shares. There are two problems with this approach:

    • if you don’t formalize the absolute number of options and have another funding round (likely at a different per-share price), your initial assessment of “value” becomes a moving target, which can lead to misunderstandings
    • it’s likely that investors will purchase preference shares of a different class to those ordinary shares that would be granted to option holders. The intrinsic value of option shares is likely to be lower than the price paid by investors for a higher-class share. In addition, it is of benefit to an employee to have as low an exercise price (the price they pay for the share) as possible, so you can end up in a conflicting situation, wanting the exercise price to be low but still trying to say to someone that the shares are “worth” much more. The advantage of share options lies in the upside — the hope that the shares will someday be worth more than the price the employee has to pay for them. Talking in terms of present-day value can be misleading and is not useful to communicate the actual potential value of the option.

Vesting and Exercise Price

A share option is an option to purchase a share in the company at a price agreed at the time of grant of the option. While a number of share options may be granted on a certain date, it is usual to permit option-holders to only exercise those options (i.e. convert them into shares) based on the passage of time or some other condition, such as the option holder/company hitting certain targets. 

The rate at which options become capable of being exercised is known as the “vesting schedule.” You will commonly see employee share options vest over a 4-year schedule with a “cliff,” which means that no options vest for the first period of time (e.g. a year) but then a full year’s-worth of options vest on the first anniversary of the date of grant. There are numerous vesting schedules that are common, such as:

  • 1-year cliff and monthly vesting over the following 3 years (total 4 years)
  • monthly vesting throughout a 4-year period
  • 1-year cliff and annual vesting thereafter
  • 1-year cliff and quarterly vesting thereafter

The arguments for different vesting schedules are:

  • because share options are used to retain employees, there should be a minimum period during which they stay with the company before they should be allowed to exercise options
  • having an annual vesting schedule encourages employees to stay until their next vesting period, but possibly increases the risk of them leaving directly after a batch of options have vested

It is not unusual for advisers and board members to have slightly different vesting schedules, e.g. over 2 or 3 years.

The exercise price of a share option is the price per share that an option holder pays if and when they exercise the right to convert the option into a share. Usually the exercise price is set at “fair market value” of the underlying share at the time the share option was granted. 

For private companies, it can be hard to assess what a fair market price is for a share. At the very beginning, the market value may be close to zero. If a company has received funding, it can use that share price as a reference point to assess fair market value. However, the value of a share subject to an option will likely be less than the price paid by an investor for a preference share or a share carrying more rights than an ordinary share. In practice, the “fair market” value of an ordinary share may be expressed as a discount off the price paid by an investor for a preference share. The discount will depend on the difference between the rights carried by the preference shares and ordinary shares and can be anything up to an 80% discount.

A really important concept for you and your option holders to understand is that, if you grant share options with an exercise price of fair market value, you are not immediately providing value to the option holder — the whole point of share options is that the option holder hopes to make money if the value of the shares increases. 

Taking vesting out of the equation, when you grant e.g. 1000 share options at an exercise price of €1.00 each (let’s say that’s fair market value), at the date of grant all you are offering the option holder is the right to buy €1000-worth of shares for €1000. The advantage to the option holder is that they do not have to hand over the €1000 immediately on the date of grant, but they lock in that price for the future and so, if and when the shares are worth €100 each, they can still buy those shares for €1.00 each and sell them for €100 each if there is an exit/sale of the company. The value is all in the potential.

When an Option Holder Leaves

The main intention behind share options and vesting arrangements is to motivate employees and others to both stay with the company and increase overall shareholder value. Where share options vest and have been exercised, the option-holder becomes a shareholder of the company and can share in the profits/value, e.g. if the company is sold.

Once someone becomes a shareholder, they will generally have the right to vote on or approve certain corporate actions. While the intention behind share options is that the subsequent shareholder will benefit from the economic rights of the share (i.e. to receive money on an exit), it is preferable that such shareholders are not permitted to “hold the company to ransom” via their voting rights. While many corporate actions require a 50% or 75% majority vote in favour, in certain circumstances, such as an acquisition, the acquirer may require that 100% of shareholders sign the acquisition documents. While there is a statutory (legislative) procedure whereby 80% of the existing shareholders can force the remaining 20% of shareholders to sell their shares, that process takes time and, as the saying goes “time kills deals.” Uncertainty is to be avoided at all costs when you are in the full throes of an acquisition.



It is recommended that all small individual shareholders (and option shareholders in particular) either (i) hold their shares via a “nominee scheme” whereby the shares are issued to a separate company which holds the shares for the benefit of the individual, or (ii) as a condition of exercising a share option, grant another person connected with the company (usually a founder-director) a power of attorney over those shares, such that the founder-director is authorised to sign any documents approved by other shareholders on behalf of the option-shareholder.

This is for two reasons: (i) so that corporate actions can be taken quickly without having to track down each and every shareholder, and (ii) so that small individual shareholders cannot take disproportionate advantage of something like an exit scenario by refusing to sign documents unless they receive something over and above their normal entitlements.

Other Instruments

We go into more detail about this in the “Raising Initial Capital” section, but both Warrants and Convertible Loans also belong here in our discussion of capital structure.


A warrant is essentially a share option; it allows the warrant-holder to subscribe for shares in the future for a price agreed today. The price can be fixed or can be expressed as a discount off a future funding round price. The difference between a warrant and convertible loan is that, with a warrant, the company is unlikely to get money upfront for granting the warrant; the money only comes in if the warrant is exercised and shares are granted. Warrants are often issued alongside a separate investment to institutional/professional investors or alongside a service or banking agreement to third-party service providers or banks.

Convertible Loans

A convertible loan is a cash loan that can be converted, usually at the option of the “loan note” holder, when a future equity (share) investment is completed. A convertible loan usually consists of (i) a Note Purchase Agreement, executed by the company and each of the people providing the loan, and (ii) a Loan Note, which is the certificate representing the actual loan.

The advantage of a convertible loan is that it is not necessary to immediately ascribe a value to the company, which can be difficult to assess in the very early stages of development. Convertible loan documentation is also usually less complex than the shareholders’ agreement required by an equity investment.

Expect to see the following in a convertible loan:

  • a conversion event: usually a future equity investment raising a minimum amount of money. This is the trigger for the loan to be converted into shares. The choice to convert can be either (i) company-friendly whereby the investor must convert unless the company decides otherwise, or (ii) investor-friendly, whereby the investor has the option whether to convert the loan or have the loan paid back.
  • a conversion price: the price at which the loan will convert to shares on a conversion event. The price can be set at a discount off the price-per-share of a future investment round.
  • an interest rate: interest would normally be either paid out at conversion or applied to subscribe for more shares at conversion.
  • a term: this is the time period by which the loan will have to be either paid back or converted. If a conversion event doesn’t happen within the term, either the loan will have to be repaid or converted to shares at a pre-determined price or for a pre-determined percentage ownership, outlined in the loan document at the outset.
  • various vetoes/permissions whereby the investor’s consent must be obtained to take certain actions. These will be similar to vetoes in shareholder agreements but are usually less detailed and more high-level.

Sometimes there will be a “cap” on a convertible loan, or a minimum percentage of share capital that the loan amount will convert into when it is converted.

Pitfall #1

You meet an adviser who sounds like they know a lot about your industry and could help you with introductions to potential customers. You ask them to join your board and promise 2% of the company when it is currently just you and a co-founder. The adviser puts in a lot of time and effort helping you develop your business and introducing you to industry players and potential investors. Your company then pivots and starts focusing on a different model, with different customers. You receive seed funding on the basis of your new business model. You never formally appointed the adviser to the board and your new investor wants to keep the board small – just you, your co-founder, and the investor as directors. While your adviser may have been useful initially, they cannot help you with your company’s new direction. You did not discuss a vesting schedule when you offered them equity. While the adviser is prepared to forego the board seat you offered, they still want the shares representing 2% of the post-seed share capital. While no one can deny the effort the adviser has put in, you believe that 2% of the company is too much to offer an adviser who will not be continuing to add value.

In this scenario, you are short of legal arguments as to why you should not have to offer a full 2% of the company in options to the adviser. While you may be able to appeal to their humanity and explain the rationale, it is not unreasonable for them to expect to be rewarded, particularly considering how much of their (expensive) time they put in trying to help the company. Having an initial discussion about vesting and setting the expectations of both parties would avoid any sticky conversations later.

Pitfall #2

Your company has been authorised by shareholders to issue up to 5% of shares as options. No centralised record of shares and options promised to employees and advisers was kept. During your first round of funding, due diligence discovers that the management team has granted options over 7.5% of the share capital. The investor says that they will go ahead with the investment, but only on the basis of the valuation assessed when they thought only 5% share options were granted. In essence, this means that the founding shareholders must make up the difference to make good on the share option promises; it comes directly out of the value of their shareholding.

Pitfall #3

An early employee was given a comparatively large grant of share options. After 5 years, they decided to leave the company. Their vested share options represented approximately 1% of total issued share capital. The exercise price for the share options was very low because they were such an early employee. On leaving, they exercised the share options and held the shares in their own name.

Three years later, the company is being sold to a US multinational. The US company demands that ALL shareholders (100%) give their consent to the acquisition. While the departed employee could be legally forced to sell their shares to the acquirer, they refuse to sign the other legal documents related to the sale. It ends as a Mexican standoff the night before the transaction is to close; the other shareholders are forced to pay the departed employee a six-figure sum for their required signature.