You’re a startup company founder with a great idea or product. After bootstrapping through the early days, and perhaps early funding from friends and family, you’re ready for more significant investment. Before you even get to discuss term sheets with your potential investors, the investors ask for the company’s capitalization (or cap) table—and after getting it, the investors suddenly lose interest. Discussion doesn’t even get to negotiation, and the investors move on. What just happened? Well, maybe your company’s cap table was the problem—was it in good shape and did it make sense? There are some common mistakes founders make with respect to cap tables. Here’s how to avoid them with good cap table hygiene.
A cap table is a record providing details on who has what ownership in a company, including the number and types of securities. At the most basic level, the cap table shows how much equity has been issued, how much is still available and who owns what portion of the company. At a more strategic level, the cap table can and should reflect who the company owners are, how the owners relate to one another and the business of the company, how control by the owners is achieved, maintained or protected, how value of the company is now and in the future shared by the owners, how much room for additional owners there is, and more. In short, while a cap table is just a record of company ownership, it is much more than just an exercise in paperwork and administration: it is a framework for the story of what company ownership means now and in the future. Founders would do well to pay attention to what story their company’s cap table communicates.
A cap table may be simple to begin with when a company has a single owner holding all of the securities of the company. But a cap table can become complicated quickly as a company grows and securities are used more broadly for different purposes – like securing talent, incentivizing performance, and raising capital. While this complexity is easily identifiable when investors come on board, even so-called simple cap tables present unappreciated nuances. The cost of not thoughtfully managing your company’s cap table is not just confusion about your ownership or the value of your investment. It may also include scaring off potential investors who translate a confused, muddled, or incomplete cap table as a “risky” or, worse yet, “bad” investment opportunity. Without a purposeful understanding of the strategy underlying your cap table and a clear and accurate presentation of that, your potential investor may just decide to move along to the next promising company.
Here are three common mistakes company founders sometimes make with regard to cap tables:
1. Failure to document and track your company’s capitalization.
Founders are busy people on whom falls most if not all of the tasks of owning and operating a startup company. In the midst of all the competition for a founder’s attention, creating and maintaining the cap table can easily be dismissed as a mere administrative task that can be done later. Even those who appreciate the importance of tracking issuances or promises to issue securities may not be doing so in a format that helps them substantively understand the current and future value or strategic future of the company. If you don’t track it, especially in a form where you can see the big picture, you might give away more securities than you should, or to the wrong people, or for the wrong reasons.
2. Commitments for securities without documenting.
A cap table provides detail on company ownership, but company ownership is not created by a cap table. The issuance of securities to owners reflected on a cap table should be based on documentation of the issued securities. Have you been promising someone options or shares, maybe even included them on your cap table? You better have the paperwork evidencing the actual issuance of those options or shares. If there is no evidence as to what securities have actually been issued, it’s a red flag for investors who can’t trust what the cap table says about who else owns part of the company—and what that means for their prospective investment.
3. Not appropriately valuing the equity.
This is a common and costly mistake. A new startup company doesn’t have any cash flow, so the founders pay with what they have readily and “freely” available: securities of the company. It can be very easy to give away 100 shares (the value of which is speculative) rather than give someone $1,000 in cash. It is a simple matter of paperwork to generate 100 shares—just print it out a piece of paper with some fancy doilies! But $1,000 in cash? If you fail to maintain a clear understanding of what the value of those shares is, not just now but in the future, you could be betting against your own company. Those recipients could end up owning a disproportionate share of the company, a problem which may prevent future investment.
Even though these and other cap table problems are often fixable, you can end up wasting valuable time (and money) getting your cap table back on track. Why not avoid them instead? Your company doesn’t need to be doomed from the start. Get serious about your company’s cap table—create it, maintain it, track it, and thoughtfully and critically use it.