Inception. A startup is owned by the founder or founders, and initial common shares with a par value are assigned to them. At this point in time, the founders own 100% of the company, and this is usually in the form of common stock, which can also be referred to as founder stock. If the founders were never to raise any outside capital and were never to give away any stock to employees or others, then they would keep all of that equity for themselves. This often happens with small businesses, but with high growth companies suitable for VC investment it is very rare to see the founders keep 100% of the business. We're going to look at how an example companies cap table might change over time. To begin with, the founders will own 100% of the common stock of the company, meaning they have 100% ownership of the company. The first dilutive event will typically occur when the founders carve out an option pool for early employee hires. This ownership carve out can also be referred to as an ESOP, which stands for Employee Stock Option Pool. So why do they do this? It's because hiring talented key employees, such as engineers for IT firms, or a top-notch sales team is extremely competitive. It is not uncommon for exceptional experience talent to have multiple offers on the table and use this in negotiations to increase the number and terms of stock options they're offered as part of their compensation package.

Founders understand that in order to eventually attract VC money, they need talented employees at the outset to quickly develop and market test their product in order to get their company to the product-market fit stage as fast as possible. The upside of providing share options to employees is that the company will not have to pay all of their compensation in cash, which is great for early stage companies, which might not have a huge amount of surplus cash. And by gaining share options, employees should be incentivized to work hard and help the company to grow to enhance its valuation, and as a result, increase the value of their stock options. So hiring top talent comes at a price. Typically, this early option pool or ESOP is set up to be between 5 and 10% of the company's shares. This is usually offered in the form of options, but can also be in the form of restricted stock or founder stock.

In our example, the companies have been awarded 7.5% of the existing shares of the company through the Employee Stock Options Plan. To facilitate this, the founders have transferred 7.5% of the shares they held in the company already to an ESOP, which will issue the shares to the employees in the future. If they exercise their options. For the founders, this means their stake in the company has been reduced from 100% to 92.5%. Or in other words, they have experienced dilution of 7.5%. The new cap table now shows the founders have a 92.5% stake in the company, and the initial employee hires have an effective 7.5% stake through their options.