Is your cap table derailing your startup's fundraising?

You’ve got your pitch down to an art, not to mention your professionally designed deck.  Your metrics are growing nicely through organic growth.  VCs are taking second and third meetings.  But recently, after sending through your cap table interest is dying out.  What’s going on?

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The cap table is usually not one of the first things founders think about when fundraising, but it’s crucial to understand how your company’s ownership structure will be seen by potential investors.  Getting this wrong can add months to your fundraising journey and can easily derail otherwise positive investor discussions.

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First of all, what the heck is a cap table?  It’s simply a list of who owns what amount of your company.  For a startup that hasn’t yet raised capital yet it can be as simple as:

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• CEO and Co-Founder: 65%
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• CTO and Co-Founder: 35%

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Obviously, as you add investors the cap table becomes more complicated.  There are two major things to be mindful of with your company’s cap table as you fundraise.

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1. Ensure that early investors don’t take too much equity in your business.

Especially in “frontier” markets I sometimes see startups apply to our accelerator program with a cap table where an early investor takes too much capital.  In one case a really high-potential startup had raised $50,000 in return for a 40% stake in their business.  The startup was at the time looking to raise an additional $300,000 in capital at a pre-money valuation of $2,000,000.  Assuming they were successful, the new cap table would look like:

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• Founders: 52%
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• Angel: 35%
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• New Investors: 13%

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The founders are at risk of owning less than 50% of their business before they even raise a Seed round!  A sophisticated investor is unlikely to invest in this business.  The risk is that because the founders have given away so much equity so early, that they will have less motivation to make the sacrifices needed to make the business successful.  An investor would also worry that there may not be enough equity left in the business to offer to future investors, and thus the business may not be able to raise the capital it needs to be successful.

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Luckily, we were able to work with the Founders and the early investor and negotiate their ownership stake down from 40% to 15% so that when the startup raised their $300,000 round the new cap table ended up looking like this:

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• Founders: 74%
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• Angel: 13%
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• New Investors: 13%

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Now we have a good looking cap table!  As a result this startup was not only able to close their $300,000 round more quickly, they were able to subsequently raise over $25 million in capital from well-known VCs in the following years.  

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Some guidelines:

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• You should aim to give away no more than 15-20% of your equity in any one funding round.
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• The founders should not own less than 50% of the business prior to a Series A round.
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• When raising seed capital the founders should have >65% of the ownership, and ideally 80%+
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• Remember that an ESOP will dilute founders even further.  Ensure your ESOP (if you even need one) is appropriate for the maturity of your business.  5% is fine until Seed, then 10% after Seed.
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• Are you valuing your startup properly?  Check out my other blog on this topic here.

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2. Ensure that you don’t have too many investors on your cap table

Many early-stage founders are happy to get a cheque, any cheque, from an investor in the early days.  After hearing “no” from investors again and again, it feels good to have somebody say “yes” and hand over some of their hard-earned cash.  But founders need to be careful not to accept too many investors onto their cap table.  Essentially, founders need to learn how to tell investors “no”.  Why does it matter how many investors you have in your business?

It’s mainly a bureaucratic issue.  There are some decisions that the company wants to make that will require the approval of all of the shareholders.  These usually include:

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• Appointing Directors
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• Issuing new shares of equity (for instance to raise more investment capital)
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• Issuing new share classes of equity (typical in VC investment rounds)
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• Changing the Constitution

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Imagine you are looking to raise a Seed round of $1 million and you have 25 existing shareholders on your cap table.  You can’t get approval to raise the round until all 25 shareholders have signed a resolution approving this.  Now imagine that your shareholders live in different countries, 5 are currently on vacation, 1 may be dead, and 3 you haven’t heard from in two years.  It’s quite possible that you may not be able to get this resolution passed anytime soon.  Meanwhile, your company is burning cash and your potential investors are losing patience…

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So how can you manage your early fundraising to avoid this situation?  The simplest is to have a minimum cheque size that an investor needs to write to qualify to invest in your business.  Startups that join Accelerating Asia typically pick $25,000 or $50,000 as a minimum, but if you're really early stage and raising $100,000 you could offer a lower number to your first few investors.  So for instance, your first angel round of $100,000 might look like:

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• Investor 1: $10,000
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• Investor 2: $10,000
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• Investor 3: $20,000
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• Investor 4: $20,000
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• Investor 5: $40,000

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This is about the maximum number of investors you would want to have on an early round like this.  Ideally you can get 2 x $50,000 or 1x $100,000.  Another reason to ask for larger cheques is that the investors will have more at stake and thus will usually be willing to offer you more value in return, such as find other investors or customers for you.  With a small cheque, it’s easy to just walk away and not engage, and easier to ignore those emails asking them to sign a shareholder’s resolution….

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Another way to manage this is to require that anyone writing a cheque below $XX is required to do so through a syndicate.  A syndicate is simply an entity set up to invest in your company.  You’ll need someone to lead this and be its representative, usually an experienced Angel.  All of the investors that can only write small cheques can then put their money into the entity and only the entity will be represented on your company’s cap table.  In return, the syndicate manager usually gets a management fee and an extra share of the eventually “carry” if/when there is an exit.  In order for a syndicate to make sense financially, you will usually need to have at least $500,000 lined up, although more tools and frameworks are coming out recently that make smaller raises through a syndicate feasible, for instance in the US there is Angelist.

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Keep in mind the value that you are offering investors.  If you truly believe in your startup’s potential then you are offering investors the deal of a lifetime. Your company’s stock is worth much more than what they are paying for it.  Having that confidence will help you manage your cap table more effectively.

Happy fundraising and good luck!

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PS. here’s is a useful tool, a Simplified Dilution Calculator from UCF Venture Lab.

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