Over the next few months, with the assistance of our expert partners, we will explore the essential factors that all startups seeking funding need to consider. This will include organising your finances, conducting due diligence, and implementing growth hacking strategies.
First up, Guy Kaufman, Startup Lead at Vestd. He gives us the lowdown on understanding cap tables, a visual representation of your company’s ownership that becomes more crucial and complicated as your startup grows.
New businesses pop up every day, many with their eyes on the prize of a lucrative exit. Even in uncertain economic times, we’ve seen companies like Loom, Uber, and Airbnb rise to the top.
But before you dream big, let’s take a look at the basics, like effectively managing equity. This is a crucial task that sets the stage for long-term success.
You’ve likely come across the term “cap table” already. Let’s unpack why your cap table matters, how to structure one, and the common pitfalls to avoid.
Understanding cap tables
A capitalisation table, or cap table, serves as a visual representation of a company’s ownership structure, detailing shareholders, their share types, associated rights, privileges, and vesting schedules. While initially straightforward, keep in mind that your cap table will grow in complexity as you attract investment and advisors. You might also want to incentivise employees with equity.
Structuring your cap table
As well as listing shareholders names and details, you’ll need to note:
- Their share total count
- Share type
- The nominal value of each share class
- Price per share
- Liquidity preferences
- Debt (like convertible notes)
- Valuation (pre and post-money)
Managing your cap table
Your cap table isn’t high maintenance now, but as your startup grows, it will demand more of your attention. You can grab a free cap table template here to make sure you start as you mean to go on.
Spreadsheet hell
Relying on manual methods, such as Excel, is risky. Human error is one thing, but a seemingly insignificant rounding error could cost you dearly later. Those pesky decimals matter.
Having a digital cap table is by far the easiest way to avoid these pitfalls and ensure 100% accuracy. But if you do use a spreadsheet (and seriously, I’d advise against it, it will get messy), be sure to revisit it regularly.
Nominee structures
Investors appreciate a clean and tidy cap table. So if over time yours becomes a bit unruly, consider using a nominee structure. This allows you to make use of the ability to separate legal and beneficial ownership.
All that means in practice is that instead of having the names of all shareholders on your cap table, you can just have one name which represents a group of shareholders.
Common pitfalls
Here are the top cap table mistakes I see that can cause serious headaches, and how to avoid them.
Steer clear of dead equity
If there’s a lot of ‘dead equity’ in a cap table – as in shareholders who have a significant stake but are no longer aligned with the company’s goals (or remotely involved) – that’s a red flag for investors.
Dead equity can make getting business-critical decisions over the line difficult. You want everybody on your cap table, past and present, to add value, so choose who gets to be on it wisely!
Vesting is best
Startup life isn’t for everybody; plans and personal circumstances change, and disagreements can do irreparable damage to once positive partnerships.
We hear so many stories of co-founders bailing out early with more equity than they arguably deserve due to the absence of formal agreements and vesting schedules, leading to unresolved ownership issues, a lot of stress and nervous investors.
That’s why founder vesting is essential (as a precaution).
You can design equity structures where shares are earned only when milestones are hit. This helps maintain a fair, equitable ownership structure, fostering trust and commitment among your team. And it’ll help you to not become an unfortunate statistic.
High-resolution fundraising fails
Using convertible notes and Advance subscription agreements is great for getting capital in the door quickly, but can be like navigating treacherous waters.
Without proper planning, you could miscalculate share dilution. And too many notes, or poorly structured notes, could come back to bite you later.
You won’t often see convertible notes in a cap table until they’re converted from debt to shares. If you do decide to use them, don’t forget about them! Forecast what your cap table will look like when any convertible notes convert.
Ultimately, you want to present the most accurate representation of your company’s ownership structure when in talks with investors.
Again, a digital cap table that records all of this could save you a lot of bother.
Poorly managed employee equity
Forward-thinking investors expect to see a proportion of equity set aside for employees as they recognise its role in motivating teams to do great things. All it takes is a bit of thought, a bit of planning and a tool to do the heavy lifting.
However mismanaging employees’ share options can lead to discontent among the team, causing them to leave with unearned rewards, or worse, raise a legal dispute.
To keep your team onside, handle their equity with care. And seriously consider signing up to a share scheme platform so they can see their options vest over time – make their equity rewards feel more real.
Cap tables provide clarity on ownership, guide strategic decisions, and foster trust. So don’t take yours for granted!
Guy Kaufman is Startup Lead at Vestd. Vestd is the UK’s most powerful share scheme and equity management platform
Looking for investment opportunities? Join us at angel investment network, where global investors meet the great businesses of tomorrow.