Hi friends,
Cap tables at base are a way to understand who owns your company.
The distribution of shares between founders, advisors, investors and employees is something that you need to keep a close eye on.
However, for early stage founders there are some pitfalls to avoid. If you make these mistakes early, you can cause yourself real difficulty later on when you have to fix them.
Today I want to highlight some potentially fatal mistakes, and how to avoid them.
This article might just save your company.
Lets get to it 🚀
Your cap table is critical to get right.
Early on it can be easy to forget to even create a cap table. It seems like yet another piece of admin that you would rather not deal with.
You didn’t start a company so you could do admin, you want to build your product and find customers. But unfortunately this is one document you absolutely need to get right.
Cap tables can start off as basic as a spreadsheet showing the breakdown of share ownership.
But as you grow, adding adding investors, advisors and employees with options, it can quicly get complicated.
If you didn’t keep it organised from get go - and avoid some killer mistakes - you can have real difficulties down the line.
It can kill your company.
You might think I’m being overly dramatic, but a broken cap table can and does kill investments. So lets do this right.
What does a basic cap table look like?
A super basic cap table might look something like the above - or even simpler when you are getting started, without any employees.
This is as straightforward as it gets, just a few lines with details of the shares outstanding for each individual.
You can get started in 5 minutes on excel, and its good practice to do this as soon as you incorporate.
If you want a template to get started, Carta have one you can download for free, or a slightly more advanced version from AVC on Google Sheets here.
Tools to help you get it right
As you continue on your company journey, your cap table will naturally evolve as you add investors, employees and advisors.
Tracking all this in Excel can start to become unwieldy, but there are of course several software solutions you can use that make it a bit easier.
Pulley and Carta are two that I am familiar with, but there are probably many other options you can find.
You will also want to get a startup lawyer who can help you out as things get more complicated.
There’s a lot to say about cap tables, but today I want to share specific mistakes that could kill your fundraise.
4 cap table mistakes that will kill your fundraise
1. Very unequal founder equity splits
“We want to make sure that founders own enough and make sure that there is a healthy option pool to attract employees,” ~ Pejman Nozad, the founder of Pear.vc
If you have founders with sub-10% equity, this is a red flag to investors. The simple reason is that having a small equity share can be demotivating for a founder, who might then not stick around.
I talked about founder equity previously, but the key point is that you should avoid egregiously unequal founder equity splits. Investors tend to prefer that equity is distributed approximately equally.
2. Founders not vesting their shares
“We pretty much won’t fund a company now where the founders don’t have vested equity because it’s just that hard to do.”~ Sam Altman
Vesting is critical to protect all founders, and the company. Even if there is one founder that has more equity, or is the ‘lead’ founder, they should also vest their shares.
If you have founders on your cap table that have large equity stakes without vesting, this is a big problem. If that founder ever leaves, they can take with them a huge stake of the company.
Having this type of “dead weight” on the cap table is going to be a big red flag for investors. In this situation, fundraising is going to be extremely challenging if not impossible, so make sure everyone is vesting from day 1!
3. Having too many small investors
Its best practice not to have too many small (5-50k) angel investors on your cap table.
Managing these investors can be an administrative pain. Try to only include investors you think are going to add value in the long term.
Another reason is that you don’t want to give away too much equity too early. Again this can raise a red flag for investors if the founders are already really diluted by the time they are raising a seed round. A rule of thumb is that you don’t really want to have given up more than 20% of the company by the time you close your seed round.
Giving away 30%+ of equity this early in the journey starts to get dicey.
If there is some reason that you want to bring on many small investors, it can be a good idea to use something like the Angelist Roll Up Vehicle. This will allow you to bring on many investors with just one entry on your cap table using something called an Special Purpose Vehicle (SPV). An SPV is a legal entity that allows investors to pool their capital.
The SPV can have a lead investor that can disseminate information and consolidate questions to make managing lots of investors easier and keeping your cap table clean.
4. Forgetting to pay for your founder shares
This isn’t directly a mistake with your cap table, but is so easy to get wrong and so important I had to include it.
You need to file a Section 83(b) election within 30 days of being granted stock. There is much to say about this, but the tldr is that if you don’t do this you will get a massive tax bill that you likely won’t be able to pay.
In fact, to expand this point, you need to make sure that you have all your records in place ready to go. Missing records or unsigned agreements (especially around IP ownership) makes you look disorganised, and can slow down your due diligence.
I hope I have shown how important having an accurate and up to date cap table is.
If you mess this up, it might simply delay the due diligence process with your potential investors, or it might take a bunch of lawyers fees to sort out. But in the worst case, if you make a big enough mess, it might kill the investment entirely.
So get your cap table down on paper, or use some software to make sure you have everything clear before you start talking to investors.
I hope you found this useful.
Until next time,
Jamie
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