How to ensure you have the right number of investors in your cap table?
A startup’s cap table often grows faster than projected, and founders normally feel the ache of a growing cap table when it’s too late. Managing a cap table has practical ramifications for a business. Each investment the company gets requires cautious management. Founders must answer investor communications, keep them updated, and seek their signatures on key changes. This article will discuss how to manage investors in the cap table and maintain a simple cap table.
Investors in a cap table
A simple capitalization table shows each equity ownership capital, the individual investors, and the share prices. As a company grows, the cap table becomes increasingly complex with growing numbers of investors. However, a complex cap table for investors is hard to manage and creates issues further down the line. This article aims to help the reader learn to avoid many investors in the cap table. Read on to get started!
What is a cap table?
A table that details all the shareholders and grants of a business is called a capitalization table or cap table. When a business has to keep a record of the total number of shares, their value, and the equity ownership of each stakeholder, it needs a cap table.
A cap table presents the company’s information, including debt and stock ownership. It includes information such as investor liquidation entitlements and total capital provided by lenders. Since almost all startups lack conventional debt lenders, the list often includes information about the shareholders and the proportion of the company they possess. Different ownership structures include preferred shares, common stock, and convertible notes. Cap table for investors impacts both current and possible future investors.
Why do companies need a cap table?
Cap tables help companies make correct financial decisions. The cap table helps manage business activities by allowing the knowledge of available options and pre-money appraisals. This might be beneficial when selecting a COO who wants business ownership. If their desired option isn’t accessible, you can easily determine how much you’ll be able to offer. It shows firm ownership. The cap table symbolizes money, which might be crucial for the firm. When the startup becomes profitable, the stock’s value may increase, and a cap table mistake may cost thousands.
Why does the cap table matter to investors?
A summarized cap table for investors is often a common practice. This makes it possible for investors to determine ownership status for internal monitoring and auditing needs. Investors frequently need to obtain a detailed list of all the shareholders or investors in the firm. While opinions on this matter vary, many people think it’s best to send business-related conversations to the executive team so they can handle and manage messages. Of course, investors will often be aware that some of their peers have also made investments, but revealing specific stock holdings, contact details, and staff equity shares is less frequent.
Investors who firmly believe they should have access to comprehensive cap tables may present their case to your company, in which you may give it some thought. Typically, major investors will have particular, private legal rights to receive recurring financial statements and cap table amendments. They could even send a delegate who is an auditor or member of the board, in which case they will have access to the data they want, as stipulated in the equity financing documents.
How to maintain a cap table for investors?
Maintaining a simple and up-to-date cap table is important for the startup’s future and securing investors’ funding. Here are some strategies to maintain the cap table for investors.
- Keep it up to date – Simple and orderly cap tables are excellent. Always update the cap table. This includes new shareholders, share transfers, stock option exercises, firm repurchases, and other events. All this might happen every day and affect each shareholder’s firm ownership. A well-organized cap table will help you make quick and knowledgeable share choices. Cap table software is favoured over the classic spreadsheet cap table. Keep the cap table and statistics organized, so they’re helpful when pitching new investors.
- Include convertible note details – Convertible notes are prevalent in seed-stage business funding. It’s good for seed-stage startups with little product or revenue traction. Instead of discounting the latter price, the corporation might delay the decision. Most startups miss including Convertible Notes on their cap table for investors. Incoming investors make judgments based on ownership dilution and are frequently startled by convertible notes. What would happen if a new investment of $1 million has $2 million in unknown notes on a $5 million pre-money valuation? The new investor may think they control 20% of the firm when it’s significantly less.
- Include your future ESOP pool plan – The workforce is the most important resource for every new startup. The most efficient method is implementing an employee stock option program or ESOP to have highly engaged employees and a strong work culture. Your ambitions for future employees and exponential company growth may or may fail, depending on how well your ESOP is laid up. Define your strategy for future employee stock option pools, particularly how you want the options to vest.
- Add pre-money valuation – Pre-money valuation, as the name implies, refers to a company’s stock worth before receiving funding from a new round. The fair value of the shares and the amount the firm should seek from new investors are references provided by adding this pre-money valuation to the business’s Cap Table when planning. This pre-money valuation also provides prospective investors with a point of reference for the percentage of the firm they will own if they invest a certain amount of money.
- Include ownership dilution – When a corporation issues new shares, it dilutes the ownership stake that the current investors possess in it. By issuing new shares, the equity stakes of shareholders are decreased. Existing shareholders are often disadvantaged when a corporation obtains extra equity capital, although dilution may occur at any time. As a result, you must provide information about potential dilution impacts by adding new shareholders to the current cap table for investors.
How to decide on the right number of investors in your cap table?
How big the cap table should be, and how many investors should be added to the table? Growing cap tables is a complicated subject specific to each company’s objectives and conditions. Let’s break it down here.
Reasons the investors and stockholders increase in cap table
There are two main reasons behind the increase in investors and stockholders. When you raise money, new investors become shareholders, and when you give away employee ownership rights, the employees become stockholders.
How you handle these factors may affect how quickly the cap table grows. If you’ve raised money from family, friends, or angel investors, you may rapidly have 30+ shareholders. If only major investors invested, your cap table will be modest. If you’ve issued stocks directly to workers (instead of setting up an ESOP), your cap table will expand faster. If you’ve set up an ESOP and told workers they may defer ‘exercising’ their options until an Exit Event, your cap table may be smaller.
Implications when number of stockholders is increasing
There are some practical repercussions when the cap table for investors increases in size. A large-cap table will sometimes have severe implications; moreover, its important to have these in mind at the beginning.
- Difficult to sign resolutions and documents – Many shareholder agreements demand stockholder approval for several matters. Most start-ups acquire approval via a ‘circulating resolution’ rather than a shareholder’s meeting. This needs shareholders to sign a voting document. Multiple signers are needed for each shareholder. This may be a laborious and frustrating process for a startup with 30+ shareholders.
- Too many opinions to run the company – Some investors wish to participate actively. Even though this advice is often valued, it may become complicated if too many investors are engaged on the cap table. It could be distracting, for instance, if 30 minor stake owners want a role in how the business should be operated.
- Reduce investor attraction – Larger angel investors and venture capitalists often like clear and succinct cap tables. This is because they know that the business can be more adaptable and won’t run the danger of being constrained by several little investors when it counts.
- Management complexity – Numerous components of the cap table will need to be continuously updated and checked. For instance-
- Valuation – Any changes to the market value of specific stocks must be represented in the appropriate entries.
- Investors – As and when new investors join, their names must be included, along with pertinent information about the amount of their investment.
- Employee Stock Options – If you provide stock to individuals working for you, you must record it. The same holds true for expiring options when workers leave the business. When options vest, they may be exercised or left to expire, or the stock may be sold or transferred. The cap table must reflect all this information and/or recognize it.
- Messy cap table – When developing and maintaining a cap table, you want to create a single source of truth – a document or point of reference that is correct and includes all important data at any given time. The first couple of years may be doable using a spreadsheet, but this gets harder as the company expands and goes through fundraising rounds. Even if you keep up, manually entering and updating data is inefficient. Many copies of the same file might wind up with various persons, causing a chaotic muddle that can be difficult to disentangle. You owe yourself, your partners, your workers, and the company to avoid these mistakes. In this case, it is best to use the software.
Strategies to ensure the right number of investors in a cap table
Now that we know the implications, the reasons to avoid many investors in cap table are clear. Let us talk about some strategies to manage the cap table for investors.
- Investment vehicle – Some minor angel investor groups could be able to make investments via their own investment vehicle as a single company. An angel investor may occasionally be allowed to participate in the round by joining an existing investment entity.
- Minimum raising amount – You may choose the minimum investments required from each investor when you launch a fundraising round. For instance, a potential investor must put down at least $60,000. In this approach, rather than having 10 investors at $6,000 each, you will only have 1 shareholder shown on your cap table for investors for that investment.
- Clear ESOP dilution – Keep your option holders informed so they are aware of any potential reasons they may be able to postpone exercising their vested options. They may often exercise options when an Exit Event is anticipated or when the employee departs and must exercise the options before that. If not, the workers often keep the options as vested but unused.
- Plan company strategy before the funding round – Strategize before beginning your funding round. Decide how many long-term investors you want on your cap table. Not many firms can require $60k, thus limiting the number of small investors in the seed stage and imposing the minimum in subsequent rounds. You might also consider their role too. Are they passive or active investors? Remember that Convertible and SAFE Notes will become shareholders.
Manage your cap table for investors on Eqvista!
As a startup founder, you must establish and maintain an efficient cap table. To be equipped to make wise choices when necessary, this cap table must be well-organized and thorough. You now see how fast-growing ownership with different investors and series funding may get difficult. Check out Eqvista’s free cap table software to achieve precise tracking and prevent errors in a cap table. It provides everything you want, from monitoring shares to ensuring that different equity regulations are followed. To learn more, contact us today!
