SeedBlink Blog


Why is a cap table a dealbreaker for VC in startup funding? [2/2]


Patricia Borlovan

· 5 min read
Why is a cap table a dealbreaker for VC in startup funding? [2/2]
How to align stakeholders in your cap table. Best practices from investors.

Learn how to align your stakeholders in your cap table. Insights and best practices from Pawel Maj, from Warsaw Equity Group.

Today, we continue our discussion on all things related to cap tables.

In the first part of this series, together with Pawel Maj, we have looked at the role of a cap table in startup life and the type of mistakes founders often make.

Now, let’s continue the journey and see when exactly cap tables are important for startups, why, and which are a few best practices investors look after if they want to invest in your company.

What is the role of a cap table in a startup?

Raising capital from VCs and targeting a strategic exit or IPO can be viable strategies for growing your startup, but each approach has distinct advantages and disadvantages.

Choosing the right path depends on your goals, resources, and industry context.

“You have two cases: you either build your startup to take the venture fundraising path and in this case, a cap table is a core asset for you. Or secondary, you grow it to exit towards a strategic investor or take the company public to stock exchange; in this case, a cap table is secondary.”

Cap table is a technicality, but it can be a dealbreaker for VCs.

“An investor will not invest exclusively in your company just because you have a great cap table, but because you have a great product, team, timing with your product to the market, traction, and other reasons.

We’ll look at the cap table to check if any obstacles will make it difficult for us to invest and if there is any dealbreaker problem. The dynamic is very important because if the cap table looks too messy, it might become a formal result for investors to lose interest in doing the deal.

In the early stages, especially when we look to invest, we decide to invest in the founders rather than the company. Why? In some cases, there might be no product yet, or the product might exist but not have any sales yet.

It’s a lottery ticket. So, from a cap table perspective, you also want to ensure this looks motivating enough for founders. It shall not create additional friction later on when life gets tougher. It’s not an easy path. It’s all blood, sweat and tears.

If there is insufficient financial motivation, and founders feel they are not rewarded enough for all the risks and effort they have invested, they might lose interest. In such case, it’s easier for them to return to a safe job, with a stable income and less stress.”

For strategic investors, the cap table doesn’t matter.

“As a strategic investor, when analyzing a company to acquire, I usually don’t care about the cap table because I want to scale technology. I want 100% of that company, so I’ll ensure all the shareholders will sell their shares.

For a while, I’ll keep the founders and crucial employees in the business to transfer knowledge and experience. In this case, founders still don’t need to own the company; they just need to be motivated enough to continue. However, this motivational part can be done through good compensation or by introducing a good ESOP program.

So, from this perspective, the cap table is not a strategic asset anymore.”

How to manage expectations between founders & investors?

Managing expectations is an ongoing process.

By continuously learning, communicating effectively, and seeking professional guidance, you can build trust and strong relationships with your investors, ultimately leading you to raise the round you need.

But where exactly can founders start? Let’s find out from Pawel’s final pieces of advice from our discussion:

“Start by educating yourself on how to manage a cap table, talk to your investors, see what their expectations are, how much your company is worth it, and make decisions while being fully conscious about risks and results.

Secondly, I’m going back to the importance of the founders' agreement. Make sure to have one in place and some kind of reverse vesting. If you choose to procrastinate, hoping for the best, life will show you it’s not easy."

Cap table best practices.

Keep information clear and updated.

“Keep your cap table updated at any point because misunderstandings and conflicts always arise if you don't.

Use dedicated software or a spreadsheet to keep all your information in one place, and when something changes, the information is communicated to all stakeholders involved. Your cap table has to show not only the percentage of how much everyone owns but also who these people are, what safe notes or convertible notes cover, and how much is allocated to ESOP.”

Stay flexible & adapt based on your company's needs.

“Startups come to me, hoping I'll lock in some capital.

They know I'm looking for a clear picture: how much skin do the founders and employees still have in the game? It's a sliding scale – early on, they might hold onto a hefty 80%, but by the time we're talking pre-IPO, that might shrink to just 20%.

There's no hard and fast rule for how much equity founders should keep. It depends on how far along their business is and how much they've had to dilute their shares to get that crucial funding. The further they go, the more they'll need to let go if they want to keep growing.”

Be open to fixing your cap table.

“In those initial meetings, I'm all about the details: how much venture capital is in there, how the fully diluted cap table looks, including all the ESOPs, convertible notes, or safes.

If it looks like the founders are getting shortchanged, I'm upfront about it. I tell them, "Look, I love what you're doing, but let's fix your cap table before we go any further." It's not about wasting time; it's about being real with them.

From my experience, startups can turn their situation around about half the time. The other half? Well, it's a tougher road. Sometimes, they've given away too much equity too early, and trying to rebalance that can feel like moving mountains.

So, what do we do? We look for solutions. Maybe existing investors will sell off some of their shares at nominal value, or we will introduce an ESOP program to founders to dilute financial investors. The goal is always the same: get the founders' equity back to a reasonable amount.”

Convincing investors to take a hit on their stake is no small feat. They're looking at significant losses, and from their perspective, why should they agree to that?

It's a tough conversation, but necessary. If a startup can't rebalance its cap table, it might never secure the VC funding it needs to reach those ambitious valuations.

“I've seen it all after more than a decade in this. Sometimes, we can fix those cap tables with some negotiation and creativity.

Other times, it's a hard no, and the startup has to figure out how to move forward with what they've got. It's a complex dance, but one that's crucial for the health and future of any company in this space.”

Before parting ways with Pawel, he also wanted to add one final counterintuitive thing that makes your life easier in managing your cap table. So, here it is:

“Think of your ownership in number of shares, not in percentages. It’s more clear and easier to calculate by everyone and not so abstract as percentages.”

Connect with Pawel:

Want to learn more?

If you want to follow Pawel’s advice and learn more about cap tables, fundraising best practices, industry trends, and a snapshot of the venture capital market right now, prepare for your fundraising round, we’ve got you covered. Read more on SeedBlink blog.

However, if you’ve got everything in place with your funding and you’re now looking at how to implement an employee stock option plan and all things equity ownership, Nimity is here to help.

Our dedicated solution has prepared an easy-to-use platform to help you have everything in place and educational guides to understand the whole world of ownership.

Subscribe to our newsletter

The place from where you get all information and details about the European startup ecosystem, technology trends, the VC and business angels world, investment opportunities, and news.

Join our newsletter

Your go-to source for European startup news, equity trends, VC insights, and investment opportunities.

© 2024 SeedBlink. All rights reserved.