A capitalization table (or cap table) is an important part of your private placement memorandum (PPM). It lists the shareholders of the company and shows their corresponding ownership shares along with voting rights and other specifics. It is typically shown in chart format with accompanying notes.
Pre-Money and Post-Money Ownership
The cap table can be used for your own purposes to better understand how your percentage ownership will change with the current capital raising round. This is important to understand, especially if the financing results in the original owners losing the necessary 50% of voting rights which gives them control of the company. A lawyer may be so focused on protecting you from legal liability that they do not adequately explain how you can keep this control, even through a significant round of funding.
If you can raise a smaller amount and spend more time proving your business model with this limited amount of financing, you can avoid giving up controlling interest in your company both now and in a future round of financing. By the time of the second round of financing, you will likely have sales revenues history and greater demonstrated interest from customers, all supporting a higher pre-money valuation of the company.
Common, Preferred, Options, Warrants
It is important that the cap table dig into the specifics, by differentiating between common stock and preferred stock. Preferred stockholders generally hold no voting rights but are paid dividends before common stockholders. Therefore, to keep control over the company, issuing preferred stock may be the way to go. However, savvy investors may want the control that comes with voting rights more than additional dividends if they believe their influence can help improve the value of the stock overall.
The cap table should include lists of options or warrants that have been issued or will be issued as well. This gives both management and prospective investors a full picture of potential future changes in ownership if and when the options or warrants are executed.
From our vast experience in raising Capital, a Private Placement Memorandum (PPM) offering is the best vehicle to accomplish an initial equity/Debt financing, which is a limited offer and sale of their company's stock, or securities, without registration under the Federal Securities Act of 1933. Compliance is significantly easier than. Complying with Reg D, provides the company, its officers, and its directors with an insurance policy of sorts regarding disclosure.
The Six Rules of REG D
Regulation D consists of six basic rules.Rule 501 covers the definitions of the various terms used in the rules. Rule 502 sets forth the conditions, limitations, and information requirements for the exemptions in Rules 504, 505, and 506. Rule 503 contains the SEC notification requirements.
The last three rules (504, 505, and 506) deal with the specifics of raising money under Reg D. Rule 504 generally pertains to securities sales up to $1 million. Rule 505 applies to offerings from $1 million to $5 million. Rule 506 is for securities offerings exceeding $5 million.
This rule is considered by many as the perfect answer for the company just starting out or one that needs to raise less than $1 million. Regulation D Rule 504 offers such companies:
Rule 504 was to "set aside a clear and workable exemption for small issuers to be regulated by state blue sky requirements, but by the same token, to be subjected to federal anti-fraud provisions and civil liability provisions."
Rule 504 exemption is provided for almost any type of organization, including corp’s, LLCs, partnerships, trusts, or other entities. However, it is not applicable to companies already reporting to the SEC (subject to the '34 Act) or investment companies.
Using Rule 504 mean that you cannot exceed $1 Million. The total offering amount under Regulation D Rule 504 can be up to $1 million in a 12-month period, less the aggregate offering of all securities sold within 12 months before the start of a 504 offering. So, if a company has raised $100,000 in private money in the previous 12 months, it can still raise up to $900,000 without being accused of breaking the rules, or "integration."
There are no specific disclosure requirements under Rule 504 (disclosing what the company is about, what it intends to do, or who is connected with it). This means that, theoretically, an issuer can have a purchaser sign a subscription agreement and purchase stock without any information about the company being disclosed. However, the rule is dependent on the blue-sky laws of each state in which the securities are offered. This means that if a state's blue-sky rules require disclosure, it must be provided regardless of Rule 504.
Entrepreneur should be aware the regardless of the amount of disclosure the issuer is willing to provide, Rule 504 does not dismiss the issuer from the federal requirements, nor is there an exemption from the fraud provisions, including the areas of material omissions or misstatements. The penalties for noncompliance are severe.
Number of Investors. With its limited disclosure requirements, Rule 504 also allows an issuer to sell securities to an unlimited number of investors. Theoretically, a company could raise $1 million by selling its stock at a penny a share to 100 million different investors. Obviously, the administrative economics are not too attractive, but there's no rule that stops an issuer from selling $500 blocks of stock to 2000 investors. Rule 504 is the only rule under Reg D that permits an unlimited number of investors.
Lastly, Rule 504 i provides for sales of securities of either debt or equity. This opens the door for combinations of both via convertible debentures. By way of explanation, convertible debentures are a debt issue (debenture) that is convertible to a preferred or, most commonly, common stock at some future date.
Offerings of $5 million or less
Rule 505 is used for offerings of $5 million or less in any 12-month period and is restricted to 35 purchasers other than "accredited investors."
There are a number of required disclosures if the sale of securities includes investors who are not accredited investors: advertising and or general solicitation are prohibited, purchasers will only receive "restricted" securities (meaning that the securities cannot be sold for a time period without registering them), your must not violate the anti fraud prohibitions of the Federal Security Laws, financial statements need to be certified by an independent public accountant or at a minimum, the balance sheet needs to be audited.
Companies must give non-accredited investors disclosure documents that are the same as those used in registered offerings. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well. The company must also be available to answer questions by prospective purchasers. The Issuer must comply with the securities laws of each state in which a person who buys the security is a resident, and must usually file a notice with that state's commissioner of corporations or similar official.
Offerings with no dollar limit Under SEC Rule 506; an issuer may issue an unlimited amount of securities, with no dollar limit, to 35 unsophisticated investors plus any number of "accredited investors." There are required disclosures, if a sale of securities includes purchasers who are not accredited investors. All non-accredited investors must be sophisticated and must sign an Investor Questionnaire acknowledging same. Advertising and a general solicitation are prohibited. The securities are "restricted securities" which may not be readily resold. There is a major advantage to 506, in that it supersedes and preempts the securities laws of all the states. This saves a lot of time, effort, and expense if the issuer is obtaining money from investors in multiple states. Form D must be filed with the SEC within 15 days after the first sale of securities and also with the Secretary of State of each state in which a purchaser is a resident.
Under Rule 506(c)
Just like 506(b). there is no limit on the dollar size and a company can broadly solicit and generally advertise the offering if: