Beware the Cap Table

So you founded your own company, congratulations! You came up with a great idea, built a team, and built a product. You are going to take over the world! But there is one thing standing in your way: money.

Startups can live and die by financing. The good news is that there are many different ways to raise money. One of the most popular/prestigious is to get an investment from an Angel or Venture Capital investor. Of course, whenever you raise money (even if it is convertible debt) you need to be aware that you are giving up a portion of your company. You may need the money, but equity is valuable, and you should protect it fiercely.

Equity is visualized/kept track of on something called a Capitalization Table (Cap Table for short). They are usually on an Excel spreadsheet, but more and more they are moving to online platforms like eShares.

Numbers and Excel spreadsheets can be super intimidating. But, founders, I encourage you to embrace the challenge and really understand your cap table. You should know it inside and out, and how different types and amounts of financing will change it. How well you understand your cap table will have far reaching consequences for the health of your company and your personal finances.

Unfortunately at the Clinic we see too many startups who take money from inexperienced investors and end up selling too much of their company too soon. While every company is different, here are some ballpark figures you should keep in mind:

  • Accelerators/incubators usually take somewhere between 5-10% of equity their portfolio companies for a combination of cash and services.
  • Angel/Series Seed investors should get somewhere between 15-33% of your company. The exact numbers depend on a number of factors, but if an investor is asking for more than 1/3 of your company at this early stage, that should raise red flags.

One of the best things you can do for your company and yourself is raise as little outside capital as possible. This means that you should bootstrap for as long as possible, and once you do raise money, be very diligent about how you use that cash so you can wait as long as possible before you raise more (if you raise more at all).

Companies that give up too much too early are in danger of scaring off future investors. When founders don’t own enough of their own company investors fear that founders, who are the heart and soul of the company, will no longer have incentives to work hard. We have seen this in several companies.

On the flip side, there are some recent success stories from the Ann Arbor ecosystem. While I won’t give away too many details for confidentiality reasons, there are some common threads. Each company raised a relatively small amount of capital (only a few million dollars, which I know sounds like a lot, but is tiny in this world). In every case the founders kept close track of their cap table and made sure they didn’t give up too much. When these companies sold, the majority of the purchase price went right to the founders, who still owned sizable (sometimes close to half) of the equity in their companies. When you are talking about acquisitions in the tens or hundreds of millions of dollars, every percentage point on the cap table is important. Many of those founders can now go on to be VCs, found another company, or never work again if they so choose.

So founders, don’t skimp on learning the ins and outs of your cap table, it will pay off in the long run!


Financing a Startup Company Series: Angels

"Angel investors" invest their own money in startups as compared to venture capitalists who invest money raised from third parties.

“Angel investors” invest their own money in startups as compared to venture capitalists who invest money raised from third parties.

This post continues our Financing a Startup Company Series and focuses on angel investors.  The term ‘angel investor’ covers a wide range of wealthy individuals who invest their own money in startup companies.  They usually focus on investing in very early stage companies that have the potential for high growth.  There are angel investors, ‘super angel’ investors who make larger investments, and ‘strategic investors who invest within an industry in which they have prior experience. Increasingly, individual angel investors are forming groups or networks to share costs, diversify risk and allow them to participate in larger deals than they could when operating alone.  Increasingly, VCs are moving into the “seed-stage” space and are launching funds that make ever smaller investments in early stage companies.

What are the advantages of angel investors? Angels often fill the gap between companies that have outgrown bootstrapping, friends and family, and the larger investments that VCs make.  Angels are often a source of funding for early stage companies that need between $100,000 to $5 million.  In addition to their cash, angels can bring contacts and leads from their prior experience working with a specific industry.

What type of investment do angels make?  In exchange for their funds, angels will take either an equity stake in the company or convertible debt. Typically, they are looking for investments that will earn them at least a 10x return within 5 years.  In order to achieve this rate of return, they will take between a ten to over fifty percent stake in the company.

What are the costs and potential disadvantages to accepting angel investments?  Angel investments are usually dilutive, meaning that the angel takes equity in exchange for their investment (either stock or through debt which can convert into equity later).  Any time founders’ give up equity, they reduce their ownership of the company and share of any proceeds upon an exit (such as an IPO or acquisition).  To compensate for the high risk of investing in early stage startups, angels take a relatively large stake (or take convertible debt which can convert into a large stake) in the companies in which they invest.  In addition, Angels will often want board seats and other management control rights that can limit founders’ freedom to operate their companies.  For this reason, it can be a good idea to get to know an angel’s reputation and to find angels that have experience in your specific industry.  An angel that likes to be more hands on isn’t necessarily a bad thing: their experience and business savvy can be a great asset for a startup.

To reduce the cost of the angel investment transaction, standardized seed round documents are available from a number of reputable sources.  Check out the this post on Yokum Taku’s “Startup Company Lawyer” blog for more information on the standardized seed documents.

For more information on Angel Investors, see our prior posts:

Should You Take Money From an Angel, and

Structuring the Angel Investment.


Angel Investors II: Structuring the Angel Investment

Entrepreneurs have a number of options for structuring an angel investment.

Entrepreneurs have a number of options for structuring an angel investment.

This is part 2 of a 2 part series on receiving angel investments.  Once your company has decided to take on an angel investor, you have a couple of decisions to make.

Convertible Notes vs. Equity Purchase: What is right for you?

As discussed above, angel investors may be flexible in how the financing is structured. Two possible approaches a financing could take are convertible notes and equity purchase. The differences between the two are discussed below:

Convertible Notes

Convertible notes act like traditional notes, but grant the investor the option to convert the balance of the note into equity instead of seeking repayment at the choosing of the investor, or automatically upon a specified date. You do not need to value the company in order to execute a convertible note. These notes are also easier to produce than full-financing documents, resulting in lower legal costs. Convertible notes will often contain a provision specifying that the note will automatically convert into equity in the event of a qualified financing, usually defined to be the closing of a set round of a specific dollar amount or higher.  In that case, the note will convert to whatever type of equity is issued in that round of financing.


In this type of deal, the investor will purchase equity in the company in exchange for cash. The investors and entrepreneurs will agree on a set price that the investors will pay for each share of the company. This is how many financing deals are structured, and may be the preferred format for an angel investor.

One thing to keep in mind when structuring an equity deal is that convertible notes previously issued by the company may have an automatic conversion provision that will be triggered by this new round of financing.  If that is the case, the value of these notes and the corresponding stock that will be issued in exchange for them must be taken into account when valuing the company.  The two different methods traditionally followed in the industry to account for the convertible notes when setting the price of the new round are:

a. Convertible notes as part of the pre-money One choice is to include the value of the convertible notes in the pre-money valuation of the company. This is complicated, though, because the value of the convertible notes is determined by the price per share at which they will convert. The price-per-share is set by the new round of financing, which under this method is determined based on the value of the convertible notes. This method will rely on an iterative excel calculation to determine the price-per-share for both the convertible notes and the newly purchased shares.  One way to estimate this calculation is to simply subtract the amount of convertible debt (perhaps factoring in the discount or cap to calculate the purchasing power of the convertible debt) from the negotiated pre-money valuation.  Generally, this will result in a lower price and so will benefit the investors.

b. Convertible notes as part of the post-money. Another option is to factor the convertible notes as part of the new money coming into  the company. The investors and the company will decide on a price-per-share for the round based on a pre-money valuation of the company that does not include the convertible notes. This will generally result in a higher price per share, benefiting the company.

Compliance with Securities Laws

The SEC considers both a sale of equity or a convertible note as a sale of a security. As such, you will want to make sure that you meet one of the SEC’s private offering exemptions and that you file the necessary forms with the SEC and with the state in which the investor(s) reside. You will want to research the requirements for your specific financing directly on the SEC website and on state websites. Do not rely on general advice. Most angel investors will be accredited investors, making the exemption under Rule 506 available to you if they are.  Generally, you will need to file a Form D with the SEC within 15 days after the sale is made.  You may also need to make a notice filing and pay a fee to the state in which the investor resides within that time frame. Note that if you are receiving money from an angel syndicate but each individual investor will be writing a check you must comply with each investor’s home state filing requirements. Be sure to check out and each state’s secretary of state website and to ensure that you comply with all regulations.  Also, note that the SEC requires that Form D be filed electronically. This will require access to the EDGAR database and may take multiple days to set up. Be sure to look into the securities filings early so that you do not miss the deadline.

In general, angel investors may be a good match for your company’s financing needs. Before agreeing to bring in an angel investor, though, be sure to assess whether this is the best fit for your company. Once you’ve made the decision to follow through with the financing, consider how to best structure deal to suit your company’s needs and be diligent in complying with necessary federal and state regulations.

Read part 1 of this 2 part series:  Angel Investors I: Should You Take Money From an Angel?


Angel Investors Part I: Should You Take Money From an Angel?


"Angel investors" are typically high net worth individuals that invest in a startup at very early stages and prior to institutional investors.

“Angel investors” are typically high net worth individuals that invest in a startup at very early stages and prior to institutional investors.

This is part 1 of a 2 part series on receiving angel investments.  As your start-up grows, your company’s capital needs will be unique to your business. While some entrepreneurs may be able to bootstrap their companies, more than likely your company will need to seek outside investors at some point.  Many entrepreneurs start with gifts or loans from friends and family. There is also the possibility of incubator financing for the first $15,000 – $50,000.  However, after you’ve exhausted this money and your parents’ and Aunt Mildred’s generosity (or before you approach them if you don’t want to have to give financial updates at every holiday and family event), the company may want to raise a pre-VC round from wealthy individuals, also known as angel investors.

The prevalence of angel investors is growing. Angel investors are often more approachable than VCs. Many form syndicates and are looking to invest in start-up companies in their area. When deciding whether angel financing is the right choice for your company, there are a few things you should consider.

Should you take on an angel?

Since bank loans are becoming increasingly more difficult to secure, an investor may be the best choice for your financing needs.  There are a lot of positive things associated with angel investors:

 (a) Geography: Many angel groups look to invest in and promote local start-ups.  It may be easier to catch the attention of an angel group rather than that of a venture capital firm. Additionally, angel investors are likely involved in your community and may provide necessary introductions to help your company grow.

 (b) Size of investment: Generally, angels are looking to invest between $100,000 and $1,000,000. If your company needs more money than the incubator or Aunt Mildred can provide, but does not necessarily fit the specifications of a VC portfolio company yet, this could be a good option.

(c) Flexibility:  Angel investors may be flexible in structuring the financing deal.  This may be attractive to entrepreneurs that want to have a say in the deal terms.

However, depending on the individual, an angel investor may not make additional investments in a company, so it may not be the best choice if you believe you will need another round of financing in the near future. Furthermore, angel investors do not always have experience in the industry of your business, and so may require additional handholding throughout the partnership. Taking on an angel seed round may also make it more difficult to raise a Series A round from VCs. Because angel seed rounds are often based on a loose valuation process, Series A VCs may believe that the valuation of the company is inflated and may be hesitant to invest.

The decision to raise an angel seed round will ultimately be dependent on your company and its needs. For many start-ups, angels are a good solution for pre-VC financing.


See Part 2 – Angel Investors II: Structuring the Angel Investment