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!