How To Build A Cap Table That Won’t Scare Future Investors

How to build a cap table that won’t scare future investors? Before investing in a company, investors are keen on examining its cap table to evaluate its ownership distribution. Dilution is one of the primary concerns investors have since it also leads to distributing profits among more stakeholders.

You’ll demonstrate financial responsibility by providing a transparent, well-organized, and concise cap table. Investors will use it to understand the rights of existing shareholders and potential dilution when the company raises additional funding.

This information helps them make decisions about whether or not to invest in the company. So, how to build a cap table that won’t scare future investors? Let’s dive in.

Understanding the Cap Table

The cap table or capitalization table is essentially a spreadsheet you’ll use to build trust with investors and streamline the fundraising process. It indicates the company’s willingness to share critical information and inspires confidence in the management. You’ll include details like:

• A detailed list of shareholders, their contact information, identity validation, and nominations
• Stock distribution among the founders, investors, employees, and other classes of stakeholders
• Percentage of holdings by each stakeholder
• Different types of shares, including common stock and preferred stock, along with the rights and privileges assigned to each
• Price per share and the dates when the shares were issued, along with their current market value
• The impact of further funding rounds on ownership percentages
• Convertible notes, warrants, and SAFEs and the terms and conditions of conversion into stock
• Employee stock option pools including information such as the number of options granted, vesting schedule, and exercise price
• Restricted Stock Units and the provisions for paying out investors in case of a liquidity event

You’ll update the cap table regularly to reflect any changes in the company’s ownership structure. For instance, after a new funding round, after issuing fresh stock, or when employees exercise their options. Make sure the information is accurate and easily accessible to potential investors.

They can also analyze how the company’s finances will shift and the potential dilution they may encounter. As the owner, you’ll take an objective overview of your cap table and identify any discrepancies. Look out for red flags that may result in investors walking away.

Conversely, an attractive cap table attracts investor interest and encourages them to back the company. It helps them make informed decisions about its viability, stability, and where to jump in.

What if You Don’t Divulge the Cap Table?

The law does not require companies to disclose their capitalization tables (cap tables) to potential investors. No regulations make it mandatory; however, it is standard practice to provide this information during the due diligence phase.

Investors may be reluctant to provide funding without the cap table and other data in your data room. At the same time, companies can choose to withhold specific details if they are concerned about leaking sensitive information to competitors.

However, providing accurate and updated information is crucial for credibility. Therefore, ensure that you include key details without using legal jargon that can complicate things.

How to Build a Cap Table that Won’t Scare Future Investors – What to Include

Investors are particularly interested in the two main stock classes—common and preferred shares. Common stock represents the ownership stake individuals and institutional investors have in the company, serving as proof of their equity stake. These shareholders may not have a claim on the company’s assets, but they hold important voting rights.

Essentially, they participate in managing and running the company. The higher the percentage of common stock they own, the greater their number of votes and decision-making authority. This information is vital, as investors want to understand who has the final say in capital management.

Preferred stockholders may not have voting rights, but they earn a fixed dividend and have preference over common stockholders in case of a liquidity event. Investors seek detailed information about these shareholders who have the right to claim assets and get priority over other investor classes.

Convertible notes, warrants, and SAFEs are also under close scrutiny. That’s because these financial instruments convert into equity when certain events are triggered. Since the conversions can impact the cap table’s dynamics, investors need to know the subsequent impact on their positions.

They are also concerned about the employee stock options you may have offered the team. Investors understand that option pools are crucial to building motivation and impact their performance. At the same time, it is crucial that these pools are managed strategically.

Eventually, the option pools convert into equity when employees exercise them, resulting in dilution. Include the information here if you have anti-dilution provisions to protect investors from excessive dilution of their holdings.

Streamlined and Professional-Looking

A great cap table presents all the pertinent information in a clean and concise format, leaving no room for complexities. Viewers should be able to find the information they need at a glance without having to search for it.

Leveraging the services of professionals and software tools is advisable to ensure the spreadsheet is appropriately formatted. Also, include proper labeling and clearly defined columns with a smooth user flow. The information should progress seamlessly from page to page with quick loading times.

Also, ensure that users can navigate between pages, enabling them to go back and forth quickly. If investors can readily find answers to their questions, it helps build confidence and speed up the due diligence process. You’ll get money in the bank quicker, and investors appreciate efficiency.

Unnecessary delays in completing due diligence will only add to the avoidable costs of fundraising.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Easily Accessible to Remote Investors

Considering that the global startup and venture capital ecosystem is closely interconnected, you must ensure easy accessibility. You’ll invest in technology and a virtual and secure data room to share the cap table with remote investors.

A cloud-based data room is not just convenient for due diligence, but it also helps you provide regular updates. Investors can log in securely and access information about their holdings. Alternatively, you can use a software application that allows you to not only share data but also deliver emails.

Remember that transparency and open lines of communication are key to building and nurturing robust investor relationships. You’ll need their support during this and all subsequent funding rounds. So, learn how to build a cap table that won’t scare future investors. And understand how to share it.

Secure Against Data Breaches and Regulatory Non-Compliance

Your virtual data room should have the necessary firewalls and security protocols to ensure the cap table information is secure. When you’re sharing financial information, you’ll want to restrict it on a strictly need-to-know basis. Only specific people should access data about investor holdings.

Integrate multi-factor authentication and checkpoints to track visitors so you can track their activities in the room. These safeguards will also alert you to unauthorized logins so you can keep the data protected.

When setting up software to share the cap table and other sensitive data, you’ll integrate protocols for compliance with regulations and securities laws. You’ll also make sure you keep up with financial reporting standards. This approach ensures the company retains its credibility and reputation.

You’ll also reassure investors that you’re doing everything possible to mitigate risks.

Historical Reporting

A robust cap table that attracts investors reflects the evolution of the company’s capital structure over time. You’ll reveal details about how capital distribution and investor ownership changed with every funding round.

Also, include fluctuations in share prices, the number of investors exiting, and the valuation at which they exited. Since your company offers option pools, the cap table will show how outgoing employees managed their stocks.

For instance, if the company repurchased the stock when employees quit, or they sold it in the open market. This information can help investors evaluate the company’s future performance and potential for returns and, thus, plan their investment strategy.

Before you read about the red flags in your cap table, also understand how to share information with investors. Check out this video in which I have explained how to relay valuable data that can influence their decisions.

Red Flags to Fix in Your Cap Table

To reiterate–investors examine a company’s cap table to evaluate the potential for dilution and the returns they can expect. Each investor class’ voting rights are also of particular interest since votes influence decision-making and, consequently, the company’s growth trajectory.

Investors would like to see that the company’s management is in the hands of growth-oriented people who will propel it in the right direction. As the company grows, it’s advisable that a significant chunk of its ownership transfers to people focusing on its future growth.

Inactive Shareholders

Inactive stakeholders own equity in the company and proportional voting rights but are not involved in its management. In other words, these entities are unlikely to contribute to the future value of the company. The advisable approach is to lower their stake by buying them out.

Early-stage and growth-stage investors contribute more than just capital. They also add value with expertise, networking opportunities, and guidance in decision-making. You’ll want more of such partnerships in your cap table. Here’s what you can do.

• Founders actively involved in building the company but have now taken on less active roles are dormant stakeholders. Their holding in the cap table should not be more than 5%. Particularly, if they are no longer with the company. Consider buying out their shares.
• Incubators and accelerators can be valuable for getting the company off the ground. Unless they are also venture capitalists contributing to future growth, you’d want to limit their stake in the company. Anything more than 5% is a downside you’d want to correct.
• Angel investors are valuable to a company in its pre-seed stage. But it’s best to buy them out as it grows. They should have a maximum 15% stake in the startup.
• Royalties to universities should never include more than 10% equity. Even if you built the company using a university’s investment fund, lower the stake as it grows. Work out options to eliminate the stake entirely if possible.

Low-Value Decision-Making Rights

As mentioned earlier, investors are concerned about who’s calling the shots and influencing how the company is run. Here’s what you should know when learning how to build a cap table that won’t scare future investors.

• You may have accepted capital from multiple small investors when building the startup. For instance, crowdfunders, family, and friends. While these entities may form part of your cap table, they usually aren’t qualified to contribute further. You’ll either buy them out or group them together, appointing a single decision-maker to represent them.
• Bringing aboard multiple VCs can also pose a similar challenge. They may have different investment strategies tailored to companies at various growth stages, which might not align with your current management or your company’s evolving goals and objectives. Fragmented decision-making can impede your company’s growth.
• On the other hand, concentrating a substantial portion of voting rights in the hands of a single investor can look unfavorable on the cap table. That stakeholder could be incompetent or disengaged from the company’s future, leading potential investors to doubt whether their votes will have real value in propelling the company forward.
• Depending on the terms and conditions of previous funding rounds, you may have offered veto rights to certain investors. These rights can create hurdles when the top management or new investors need to make major decisions. Incoming investors may not want to go through the hassles of navigating the veto rights. They may prefer to withhold funding instead.

The Takeaway!

As the founder, you will have accepted funding from different classes of investors while the startup was in its infancy. But now that the company is poised for accelerated growth, you’re ready to bring in strategic investors. These investors can contribute a lot more than just capital.

To facilitate this, you may need to undergo a substantial recapitalization to address any potential concerns. One of the best strategies for building a cap table that won’t deter future investors is to renegotiate terms with existing investors.

Particularly with those who don’t contribute additional value in terms of expertise, mentoring, and guidance. Revise and restructure the cap table with the help of experienced legal and accounting teams. Their counsel is essential to ensure compliance with regulations and tax implications.

Get your cap table ready for the next group of investors who will aid in effective decision-making. And position the company for swift growth and success.

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