The cap table is perhaps the single most important business document that all startup founders should know and understand. The cap table contains detailed information about who owns the company and exactly how much they own in terms of the number of shares of stock. The typical cap table contains detailed information about the shareholders of a startup, the kinds of shares they hold, the number of shares they have to their name, and all the other legal rights and options they have.
Many startups begin with a great idea and a plan on how to sell it. But one thing that all startup founders should learn is that cap table planning is one of the most crucial keys to their success. If you and your friends are starting up a great idea, keep in mind that your capitalization planning should be as thorough as the distance of your vision and foresight. Here are some of the things that all startups should know about cap table planning.
Cap Table Planning
- Pre-Seed: List Down The Founders
The first thing that founders have to do after they’ve decided to put up a company for their brilliant idea is to list down the founders and incorporators. This may seem like a simple task of listing down the names and other contact details of everyone who will take part in starting up the corporation. But from the point of view of cap table planning, this is a very important part of mapping out how the startup will be grown in succeeding years.
The founders of the startup are the ones who would have the greatest motivation to make the business succeed. They should always have the motivation to strive and work for the success of the startup. This can only be ensured if they have a higher stake or larger exposure in the capitalization structure. Venture Capital (VC) specialists suggest that the founders should always have a share of between 67% to ideally 80% of the capital structure. This would also give them enough allowance to unload shares for investors in future fundraising.
- Seeding: Create A Shareholder Distribution Plan
The other important part of cap table planning is that the founders have to create a plan on how shares of stock will be distributed later on when there are already investors and shareholders other than the founders and founding employees. The founders should plan how stocks will be structured into preferred, common, and convertible securities. Some who grant bridging loans also ask for equity. They should also map out how the Employee Stock Option Program (ESOP) would be managed as the number of shares issued expands with each round of fundraising.
VC specialists suggest that the total share of angel investors in the capitalization structure shouldn’t be more than a fifth (20%) before any first round of fundraising. This would give enough room for other investors to come in. It would also allow founders to sell some of their shares without losing majority stake in their own company. VC specialists also suggest that ESOP should be maintained at around 10-12%.
- Growing: Create A Fundraising Plan
The next part of cap table planning is to plan ahead how you’re going to raise more money to grow your start up. Additional investments and capitalization are important in every stage of a startup’s growth and development. In the early stages, a startup needs money to pay for its operational expenses as well as capital outlay expenditures to buy assets and equipment. It also needs money for marketing and business development to enable it to promote its products and services. All these things need money.
But a startup should have a well-thought of plan on how to execute fundraising activities. The thing with fundraising is that more money comes in, but more people also have a stake in the company. With more investors coming in, the share of the existing shareholders including the founders would be diluted. This means that the percentage of the company owned by the existing owners would diminish because of the new co-owners.
Even the portion of the shares reserved for ESOP would go down, which may affect the interests of the employees in the startup. The founders should plan ahead as much as they can how much ownership percentage of the company they’re willing to unload to newcomers with each new round of funding.
- Plan For Complexities
Startups usually create their cap tables using popular spreadsheet software applications. It’s easy at the start and most of them don’t see the need to buy proprietary cap table software yet. Many of these startups began in the garage or dorm room of one of their founders. But the founders should also have the foresight to prepare for the complexities later on when more investors and co-owners come in. They should consider the following:
- Need for advanced cap table software later on
- Need to retain a corporate lawyer specializing in capitalization structuring and securities transactions
- Need to retain someone knowledgeable in cap table mathematics and computations
- Need to retain someone later on who can review the different contracts, Simple Agreements for Future Equity (SAFEs), convertible notes, and other legal documents that they’re going to issue and sign to accommodate new investors
Cap table planning is one of the most important things that all startup founders should learn how to do well. A cap table is a crucial tool in growing the startup because it clearly shows who owns the company. Moreover, investors use it as a reference to check how many shares they have in the organization. While would-be investors utilize it to analyze and assess how the startup is doing and where it could be headed.