As a founder, you may be told to start reading about the cap table and how it works for the organization. This is one of the first documents, your investors will ask for before investing in your firm. Do you want to know why?
If you aren’t aware of the benefits of keeping a cap table for your firm, then you would say it is a standard spreadsheet in the first instant. But believe it; cap tables are one of the essential documents that every business owner should have. This simple document, in short, a standard spreadsheet, can do wonders for the business. This shows a lays out about the company’s stakeholders, and how many shares each person owns.
You would say, it is like a simple spreadsheet, then you can build it yourself, we don’t need to have a cap table. Well, as a company starts growing its wings, more people come on abroad to seek ownership. Eventually, the equity’s ownership column will keep on increasing and becoming complex. Therefore, this complexity is dissolved by the use of the cap table. Every new investor wants to add their name to the cap table (to get on your cap table).
Investors are quite aware of the benefits and importance of keeping a cap table for the firm. That’s why they always ask for the company’s cap table to know how the new addition of investors in the ownership will be affected. The cap table portrays this whole story. Moreover, the work of the cap table doesn’t end here. It also incorporates the signing and drafting of legal documents, communicating with the shareholders, complying with regulations, and recording transactions.
Importance of Cap Table
Let’s take an example to get an overview of the capt table’s importance for the firm:
As a matter of fact, a company’s cap table clearly entitles the equity and debt ownership of the stakeholders or investors. For several startups, this table is just like a list of the stockholders, and their ownership percentage in the firm. Generally, startups don’t mention traditional debt lenders because they don’t want to attract them. So, it is all about the equity in the cap table. But, equity can appear in numerous forms, such as common stock to preferred stock to convertible debt, all with various implications for current and future investors.
Let’s read an example of cap table:
5% Convertible Notes:
- Jony Wadya $100K (converts to 100K shares at $1.00/share=3.6%)
- Samantha Ross $100K (converts to 100K shares at $1.00/share=3.6%)
- David Stockfield, Investor $50K (200K shares at $0.25/share=7.3%)
- Williams Smith, Investor $25K (100K shares at $0.25/share=3.6%)
- Damon Simon, CEO (1.0MM founder shares at $0.00/share=36.4%)
- Stephen Mills, CTO (500K founder shares at $0.00/share=18.2%)
- Harvey Pearson, CFO (500K founder shares at $0.00/share=16=8.2%)
Employee Stock Options Reserve (250K=9.1%)
- Total Shares Outstanding Today (2.30MM shares=83.6%)
- Total Fully Diluted Shares Outstanding (2.75MM shares=100%)
Please pay attention to the cap table calculation; you would understand that it is a liquidity rank order, with the convertible noteholders, having the most senior security paid back before anybody. After that, it comes to the rights of the preferred equity holders and finally followed by the lowest ranking common shareholders of the business.
That was the mathematical example of how the cap table works. Now, let me give you one more example, what I did wrong and failed to attract the investors towards my business. Let’s walk through the example:
How I Found My Mistake and Started Working on Cap Table Management?
When I founded my company I faced numerous issues, especially about managing the cap table for my firm. It was just like a simple DIY spreadsheet for me before I got a proper understanding of the cap table’s importance. When I started the firm, I operated the business with my three family members, friends, and four investors before seeking the first seed financing from an early-stage fund.
Using a simple Excel sheet, it became cumbersome to add all the investment and then divide it into equity. It was taking a huge time. And understanding the dilute effect of the new financing round on the current shareholders seemed next to impossible.
When I ask any new investor for funding, I have to look at my cap table to make it useful again. But nothing happened! To make this process straight and easy for me, I encountered these excellent rules, which helped me to make them capable, interesting, and productive. Do you want to know?
Major Things Investor Look in Your Startup Cap Table
Let’s read about them!
Don’t add too many investors in your firm’s cap table. Cap table containing numerous investors is like a red flag for most of the investors. I would advise you not to have a lot of investors. It seems very distracting to the new investors. It gives a sense of risk to new investors. After all, investors seek to own large parts of the company.
Missing obvious assumptions on the cap table at some point is inevitable. There are some chances that you would miss it. But don’t try that. Sometimes, it could lead to the investors’ loss by missing anything that makes your cap table risky or an exit scenario seem impossible for investors. Forgetting to include a single investor’s 2x liquidation preference could be the life or death of an investor’s fund.
Don’t fall for the favorites. Believe it, the cap table is not a great place for such a type of attitude. There is no denying the fact that it is human behavior to favoritism, but don’t do this with the Cap Table. It would become easy for you to calculate the exact terms during an exit. In this way, the calculations part becomes too simple, which mitigates the risk factor.
As a fact, the cap table entitles the equity percentage of the investors on the firm. If you are exchanging any work in the equity exchange, it becomes your responsibility to show up on the cap table. Investors like to see a complete team with long term incentives to stick with the business. Here would be your bonus time to have an effective cap table for your firm.
Optimize the Terms
Always remember to optimize all the terms in the cap table. This will make the entire company have a taste of success. When your investors offer a unique offer, then repay them with a really good deal or an advisory or brand role. This will add a loyalty tag in your firm.
Behavior of Other Investors
Some investors also look for the behavior and attitude of other investors in your firm. They are really inquisitive to know, ‘who are the other investors?’ How will they respond around the board of directors’ table? Are they friendly?
And last but not least, the investors also look for the liquidity preference in the cap table. This preference gives the shareholders the first dilution during the liquidity. In short, the shareholders who have been given the liquidation preference get their money before anyone else gets anything at all. I think this can be used as a game-changer!
Managing a cap table and the equity compensation really takes a lot of research work, planning, and thought processes. It would be good to seek some good advice from the successful founders, investors, and lawyers since a clean cap table and solid equity compensation plan can be worth more than a million-dollar investment alone.
About the Author:
Sarath CP is a Digital Strategist and Consultant, Growth Hacking Specialist worked for both startups & big brands, helped them to build a strong brand presence and achieve sustainable business growth. Follow him on Twitter