Managing Your Cap Table: 6 Practical Principles
A cap table is the ultimate business card for your company. It reflects how you have built the business and where you can take it. And managing that process well can be crucial for running the company well. Here are six practical principles to help.
1) Planning the Cap Table
If you are looking at a VC as just a source of capital you are probably better off raising the money from many other sources, including crowdsourcing and bank loans. Bringing on the right VCs at the right time means you capitalize on their strengths, whether it be with advice, hiring, opening doors to a partner, or helping close with a client. As a general rule, the series A and B investors are looking for 20–30% of the company, and C and D are 10–15%. If you are doing financings outside those norms then make sure to factor in your planning. You don’t want to be in a situation where you have traded away too much of the company too early on, it will affect your own morale but also make it harder to bring in other investors.
2) Fixing the Cap Table
But say you actually did that, namely you accidentally or intentionally didn’t negotiate as well with earlier investors, whether it’s by giving too much of a stake or other terms like liquidation preferences. One way to compensate is by having your existing investor sell their shares to the new investor — they get an exit, the new VC gets the stake they are looking for, you don’t get unduly diluted. The challenge here is most new investors would rightfully want new capital to help in building the business, not in adjusting ownerships. At the very extreme case, you can also recapitalize the entire company by shutting it down and restarting. This is obviously a last-resort option that Boards typically only approve if it involves critical financing preserving the company’s assets.
3) The Option Pool
The norm for quite some time is to allocate ~10% at the time of series A for future hires. Think carefully at the time of your series A because increasing your option pool in the future is likely going to be more tricky as it will dilute the investors who came in. In those cases, occasionally founders will choose to dilute just themselves, typically to bring a key hire on board.
4) Right of First Refusal (ROFR)
In the context of cap tables, ROFR basically means that any equity holder (founder, investor, employee) wishing to sell his / her shares has to offer the them first to the company. In Silicon Valley this has been an overwhelming norm for companies so they can protect themselves from their shares ending up in undue hands. Well placed ROFRs will keep your cap table clean.
Pro-rata means the investor has the right to participate in a future round to maintain his / her ownership, it’s is a standard way to reward existing investors for believing in the entrepreneur. But pro ratas can also squeeze your cap table so it’s a wise practice to offer them thoughtfully to your investors. If you know a fund will only add value in the seed then you may want to negotiate the pro rata provision. Or you can also put thresholds around the pro-rata, guaranteeing it only if the investor owns at least a certain percentage of the company.
6) Founder Shares
You can disassociate ownership from control. For example, a founder and an investor could both own 10% of the company and participate equally in the financial upside, but when it comes to Board matters the founder’s shares are worth say 3x more. Creating a different class of shares is a very common practice in corporations and startups lately have been adopting more dimensions than just preferred versus common. Investors may obviously balk at disproportionate control with management so, like many matters of governance, this is a generally a series of negotiations and conversations.
Have any other practical principle to add around cap tables? Comment away. And a Like keeps this author incentivized in writing more articles so always appreciated.