A cap table is more than a financial document, it tells the story of a company – how it is managed, what are its future perspectives and how the founders are (or aren’t) able to think and plan long-term.
As a General Partner at Fortech Investments, I’ve seen hundreds of cap tables. While some were exemplary, some were pretty messy, to say the least. The problem is that these messy cap tables make a start-up uninvestable, no matter how good their business or product is. Most are messed up in the beginning, when the founders made some wrong decisions. These early decisions end up having a significant negative impact on the cap table in the future.
The good news is that most of these cap tables can be cleaned up, but only when all shareholders are involved. Here are the most common mistakes I’ve seen, what they signal to investors, and a few tips on how to fix them:
Founder equity problems
Most mistakes I’ve encountered have to do with the ownership of founders, especially when they own too little of their company. When investors see this, they worry that the founder will not be motivated enough to lead their company in the long run. Since we invest in the early stages, the founders are our biggest bet and we want them to take their venture as far as possible.
It’s alarming when founders own less than 70% before their seed round, as they will have to give away much more equity as they grow. Ideally, by Series A, they need to own at least 50%.
Another red flag is when the equity is shared unevenly among founders, making us question if they all bring value to the company.
Fundraising rounds not being planned
A cap table is not something you can figure out as you go. Even from day 0, founders need to plan the evolution of their company, in terms of rounds, valuations, and equity. The cap table should be used to perform future scenarios, all the way to the exit value. By doing this, they will be able to reverse engineer it and figure out how much to give away at each round. They should always keep in mind things like dilution from follow-on rounds and downside protection.
At Fortech Investments we also create future scenarios using the start-up’s cap table, to understand how the value of our shares will evolve. We have a simple Excel that we also provide to the founders, so they can easily plan their rounds too.
Dead weight on the cap table
Another common issue I see is dead weight on the cap table. Dead weight, or inactive equity, is defined as significant equity stakes (more than 10%) owned by founders, advisors, angels, or other shareholders who are not active in the company anymore.
When it comes to ex-founders who are no longer in the company, it’s debatable – if they did provide value in the early days and made a significant impact, that might not be considered dead weight, especially if it’s less than 5%.
If you have dead equity on your cap table, I would advise you to check for provisions that allow you to remove them or just try to talk to them so they are comfortable being bought out.
To prevent dead equity, include the right terms and conditions in the shareholders’ documentation, such as vesting schedules or buyback provisions.
Fragmentation – Too many shareholders on the cap table
When it comes to cap tables, “strength is in numbers” indeed, but not in the number of shareholders. The number itself is not necessarily a problem, but the fact that it is extremely hard to align everyone in making decisions and, of course, in signing documents. VCs want start-ups where the most equity is owned by those who drive the company – the executive team and active investors.
Having too many voices causes uncertainty and poses significant risks, the biggest being fragmentation – when a company is owned by many small investors without a clear lead, making consensus on decisions difficult.
If you find yourself in this situation, try to pool the smaller shareholders in an SPV and, ideally, with a single representative.
Concentration – Too much equity owned by one shareholder
Concentration, the opposite of fragmentation, is also possible. An investor owning more than 20% is a threat to the health of the cap table and the overall ownership structure of the start-up. When it comes to decision-making, they will overshadow the involvement of new investors or smaller ones.
To avoid this, discuss with the rest of the investors to contribute more in the next round or discuss a partial buyout with new investors.
Valentin Filip (opening photo) is the General Partner at Fortech Investments where he invests and partners with founders in Energy, Healthcare, FinTech, Automotive, and Real Estate. If you’re looking for capital funding or joint venture partnerships, drop him a message on Linkedin.
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