A Seat at the [Cap] Table

What is a cap table?

A capitalization table, or "cap table," is a ledger that outlines the ownership structure of a company. It lists all of the company's securities, such as stocks, options, and warrants, and shows the percentage of ownership held by each shareholder. The cap table also shows the value of each security and the total ownership percentage of each shareholder.

Cap tables are used by companies to track and manage their ownership structure, particularly as it changes over time through events such as financing rounds, stock issuances, and acquisitions. They are also used by investors to understand the ownership structure of a company and to determine their own ownership percentage and potential return on investment.

Why is managing your cap table important?

Managing your cap table (capitalization table) is important because it provides a clear and detailed overview of your company's ownership structure, including who owns what percentage of the company and what type of securities they hold. This information is critical for a variety of reasons, including:

• Raising capital: When you need to raise capital for your company, investors will want to know what kind of ownership stake they can expect in return for their investment. A well-managed cap table will make it easier for you to present this information to potential investors.
• Valuation: Your company's valuation is largely determined by the ownership structure of your company, as well as the type and amount of securities that are outstanding. A cap table in good order will make it easier for you to determine the value of your company and its securities.
• Decision-making: A clear and accurate cap table will help you make informed decisions about things like issuing new securities, buying back existing securities, or issuing dividends.
• Compliance: A cap table is also important for compliance purposes. For example, if your company is planning to go public, you'll need to provide an accurate and up-to-date cap table as part of the registration process.

Managing your cap table is important because it helps you stay organized and informed about the ownership structure of your company, which is critical for making informed business decisions and maintaining compliance with relevant regulations.

Why do investors care about your cap table prior to investing?

Investors care about a company's capitalization table, or "cap table," because it provides information about the ownership structure of the company. This can be important for investors because it can affect their potential returns on investment, as well as their ability to influence the direction of the company.

Here are a few specific reasons why investors might be interested in a company's cap table:

1. Ownership stake: The cap table shows how much of the company is owned by different stakeholders, including founders, employees, and investors. This can help investors understand how much ownership they will have if they invest in the company.
2. Valuation: The cap table can also provide information about the valuation of the company, which can be important for investors to know in order to understand the potential return on their investment.
3. Voting rights: The cap table can also show which stakeholders have voting rights in the company, which can be important for investors who want to have a say in the direction of the company.
4. Dilution: Finally, the cap table can show how much dilution, or the decrease in ownership stake, an investor might experience if they invest in the company. This can be important for investors to understand, as dilution can affect the potential return on investment.

The cap table is an important tool for investors to understand the ownership structure and potential risks and rewards of investing in a company.

What are the different types of securities a private company can issue to investors?

Private companies can issue several types of securities to investors, including:

• Equity securities: Equity securities represent ownership in a company, such as common stock or preferred stock. Investors who hold equity securities are entitled to a share of the company's profits and may also have voting rights.
• Debt securities: Debt securities are a form of borrowing, in which the company promises to repay the principal amount plus interest to the investor. Examples of debt securities include bonds, debentures, and promissory notes.
• Convertible securities: Convertible securities can be converted into equity securities, such as common or preferred stock, at a later date. Convertible securities may offer the potential for appreciation in the value of the underlying equity, as well as the opportunity to receive regular interest payments.
• Derivatives: Derivatives are financial instruments that derive their value from an underlying asset, such as a stock. Examples of derivatives include options.
• Hybrid securities: Hybrid securities combine elements of both debt and equity securities and may offer investors the opportunity to participate in both the income generated by the company and the potential appreciation of its assets. Examples of hybrid securities include convertible bonds and preferred stock.

It's important to note that the specific types of securities that a private company can issue will depend on a variety of factors, including the company's business model, financial condition, and regulatory requirements. It's always a good idea for investors to carefully review the terms and risks associated with any investment before making a decision.

What are the aspects of a private startup preferred share class?

Preferred shares issued by a private startup company may have some unique features compared to those issued by a publicly traded company. Some common aspects of a private startup preferred share class include:

1. Liquidation preference: This is the amount that the preferred shareholders are entitled to receive before common shareholders receive any distribution in the event of a liquidation. The liquidation preference may be equal to the original purchase price of the preferred shares, or it may be a multiple of that amount.
2. Dividends: Private startup preferred shares may have a dividend rate that is either fixed or variable. A fixed dividend rate means that the holder is entitled to receive a predetermined amount of dividends on a regular basis, while a variable dividend rate means that the amount of dividends may fluctuate over time.
3. Conversion rights: Private startup preferred shares may be convertible into common shares at the option of the holder or automatically upon the occurrence of certain events, such as an initial public offering (IPO) of the company's stock.
4. Voting rights: Private startup preferred shares may have voting rights, which allow the holder to participate in the decision-making process of the company. The extent of the voting rights may vary depending on the terms of the preferred shares.
5. Anti-dilution protection: Private startup preferred shares may include provisions that protect the holder against dilution, which occurs when the company issues additional shares of stock. These provisions may include a weighted average adjustment or a full ratchet, which adjust the conversion price of the preferred shares to compensate for the dilution.

What are pro-rata rights?

Pro-rata rights, also known as "preemptive rights," are a type of right that allows existing shareholders in a company to maintain their percentage ownership in the company when new shares are issued. Pro-rata rights allow existing shareholders to purchase a proportionate number of the new shares being issued, in order to maintain their percentage ownership stake in the company. For example, if an existing shareholder owns 10% of a company and the company issues new shares that represent a 20% increase in the total number of outstanding shares, the existing shareholder would have pro-rata rights to purchase 10% of the new shares, in order to maintain their 10% ownership stake in the company. Pro-rata rights are typically granted to existing shareholders as a way to protect their ownership interests in the company and to ensure that new issuances of shares do not dilute their ownership.

What is a SAFE?

A SAFE, or Simple Agreement for Future Equity, is a financial instrument that is used to fund startups and other early-stage companies. It is similar to a convertible note, but it does not accrue interest or have a maturity date. Instead, it gives the investor the right to receive equity in the company at a later date, typically when the company completes a future financing round or reaches certain milestones.

SAFEs are designed to be simple and flexible, and they are often used in place of traditional equity financing in the early stages of a company's development. They are typically less formal and less expensive to negotiate and document than traditional equity financing, and they can be used to quickly and efficiently raise capital from a large number of investors.

However, SAFEs do have some drawbacks. Because they do not have a fixed valuation, investors may end up with a smaller ownership stake in the company than they would have received if they had participated in a traditional equity financing round. Additionally, SAFEs do not provide the same level of protection to investors as traditional equity financing, and may not be suitable for all investors.

What are phantom shares on a cap table?

Phantom shares, also known as "phantom stock" or "shadow stock," are a type of equity compensation that is typically used to reward employees or executives in a way that is similar to stock ownership, without actually giving them ownership in the company. Phantom shares do not have any voting rights or entitlements to dividends, but the holder is entitled to a cash payment or benefit equal in value to the value of a certain number of the company's actual shares, as determined at the time of the payment or benefit. Phantom shares are typically used as a way to align the interests of employees or executives with those of the company and its shareholders, and can be an attractive option for companies that want to reward their employees without diluting the ownership of existing shareholders.

Why is using a professional cap table management system better than Excel?

There are several reasons why using a professional cap table management system might be better than using Excel for managing a company's cap table:

• Accuracy: A professional cap table management system is designed specifically for this purpose and has built-in checks and balances to ensure the accuracy of the data. In contrast, Excel spreadsheets are prone to errors, such as typos or misformulas, which can lead to incorrect calculations and decisions.
• Efficiency: A cap table management system automates many of the tasks that would otherwise have to be done manually in Excel, such as calculating dilution or issuing new equity. This can save a lot of time and effort, especially for companies with complex cap tables.
• Security: A cap table management system typically has robust security measures in place to protect the data, such as encryption and access controls. In contrast, Excel spreadsheets can be vulnerable to unauthorized access or data breaches.
• Collaboration: A cap table management system typically has built-in collaboration features that make it easy for multiple stakeholders to view and update the cap table in real-time. This can be more difficult with Excel, especially if multiple people are working on the same spreadsheet.
• Scalability: As a company grows and the cap table becomes more complex, it can become increasingly difficult to manage in Excel. A cap table management system is designed to handle large amounts of data and can scale with the company as it grows.
• Differentiate: If you value your equity show investors, employees, and key stakeholders that you value it by professionally managing your cap table. Provide access and enable them to see their wealth creation and make an intangible asset, tangible.

What is the difference between pre and post-money valuation?

Pre-money valuation is the value of a company before it receives any outside investment. It represents the value of the company based on its assets, revenues, and potential for growth.

Post-money valuation, on the other hand, is the value of a company after it has received outside investment. It considers the value of the company before the investment (the pre-money valuation) and the value of the investment itself.

For example, if a company has a pre-money valuation of $5 million and receives a $2 million investment, its post-money valuation would be $7 million ($5 million pre-money valuation + $2 million investment).

Pre-money valuation is often used in the process of fundraising, as it helps determine the equity stake that investors will receive in exchange for their investment. Post-money valuation, on the other hand, is often used to evaluate the performance of an investment after it has been made.

How should startups think about their options pool size?

The size of a startup's options pool refers to the number of equity options that are set aside for employees, advisors, and directors. The options can be exercised at a later date to purchase shares in the company at a predetermined price, known as the exercise (strike) price.

There are a few factors to consider when determining the size of the options pool:

• Stage of the company: The size of the options pool should be appropriate for the stage of the company. For example, a company in the early stages of development may have a larger options pool to attract top talent, while a company that is further along in its development may have a smaller options pool.
• Future funding rounds: The size of the options pool should also take into account future funding rounds. If a company plans to raise additional capital through venture funding, the options pool should be large enough to provide equity incentives for new employees, but not so large as to dilute the holdings of existing shareholders.
• Number of employees: The size of the options pool should be based on the number of employees that the company expects to hire. It's generally recommended to set aside a certain percentage of the company's equity for the options pool, with a smaller percentage set aside for the founders and early employees and a larger percentage set aside for future hires.
• Industry standards: It's also helpful to consider industry standards when determining the size of the options pool. This can help ensure that the company is competitive in attracting top talent.

The size of the option pool can have several consequences for a startup.

If the option pool is too small, it may not be able to attract and retain the talent it needs to grow and succeed. In competitive industries, top candidates may be more likely to choose companies that offer a larger equity stake.

On the other hand, if the option pool is too large, it can dilute the equity of existing shareholders, including the founders and early investors. This can be especially problematic if the company's valuation increases significantly over time, as the dilution will be larger in absolute terms.

In general, it's important for a startup to strike a balance between having a sufficient option pool to attract and retain the talent it needs, while also being mindful of the potential dilution to existing shareholders.

Ultimately, the size of the options pool should be determined based on the specific needs and goals of the company. It's a good idea to seek the guidance of a legal or financial advisor to help determine the appropriate size for the options pool.

Why should private companies issue options as part of employee compensation?

Stock options can be a useful form of employee compensation because they can provide employees with a financial stake in the company and align their interests with those of the company's shareholders. By giving employees the opportunity to purchase company stock at a discounted price in the future, stock options can also serve as an incentive for employees to stay with the company and work towards its success.

There are several benefits to issuing stock options as part of employee compensation:

1. Motivation: Stock options can provide employees with a sense of ownership in the company, which can motivate them to work harder and contribute to the company's success.
2. Retention: Stock options can help to retain top talent by providing employees with a financial incentive to stay with the company.
3. Attraction: Stock options is a valuable benefit to attract top talent to a company.
4. Alignment: Stock options can align the interests of employees with those of the company's shareholders, as both parties stand to benefit if the company's stock price increases.
5. Flexibility: Stock options offer companies the flexibility to tailor the terms of the options to meet their specific needs and goals.

Overall, stock options can be an effective tool for companies to motivate, retain, and attract top talent, and to align the interests of employees with those of the company's shareholders.

Vesting schedules for startup options.

In a startup company, stock options are often granted to employees as part of their compensation package. A vesting schedule is a schedule according to which an employee earns the right to exercise their stock options.

There are several types of vesting schedules that may be used in a startup:

• Cliff vesting: This is the most commonly used and a type of vesting schedule in which the employee must complete a certain amount of time with the company (e.g., one year) before they are eligible to exercise their stock options.
• Graded vesting: This is a type of vesting schedule in which the employee earns the right to exercise their stock options over time. For example, an employee may vest 25% of their options after one year, 50% after two years, and so on.
• Accelerated vesting: This is a type of vesting schedule in which the employee's options vest faster than they would under a normal vesting schedule. This may be due to the employee being terminated or the company being acquired.
• Milestone vesting: Milestone-based vesting is a type of vesting schedule that is based on the achievement of certain milestones or goals. In a milestone-based vesting schedule, an employee or executive will receive ownership of a certain number of shares or options only after certain milestones have been achieved. These milestones might be related to the company's performance, the employee's job performance, or other factors. For example, an employee might receive vesting of a certain number of shares or options if the company meets certain financial targets, or if the employee meets certain job performance goals. Milestone-based vesting is often used as a way to align the interests of employees with those of the company, and to ensure that employees are motivated to work towards the company's goals. It is also a way to structure equity compensation so that it is tied to the performance of the company or the individual, rather than being granted all at once.

It is important to note that vesting schedules may vary from company to company and may be negotiable as part of the employment agreement.

When does a company need a 409A?

A company may need to have a Section 409A valuation, also known as a 409A valuation, if it provides certain types of deferred compensation to its employees, such as stock options or deferred bonuses.

Section 409A of the Internal Revenue Code sets out rules that apply to deferred compensation plans, including requirements for how the value of the deferred compensation must be determined. In order to comply with these rules, a company may need to obtain a 409A valuation to determine the fair market value of the deferred compensation it is providing to its employees.

It's important to note that there are specific requirements and rules that must be followed when conducting a 409A valuation, and the process should be performed by a qualified professional with expertise in this area. If a company fails to comply with the requirements of Section 409A, it may be subject to significant tax penalties.

How can a startup provide liquidity for the current stakeholders of a private company?

There are several ways to provide liquidity for the current stakeholders of a private company:

• Offer shares for sale: One way to provide liquidity is for the company to offer some of its shares for sale to interested buyers. This can be done through a private placement or a secondary market transaction.
• Implement a dividend payout: Another option is for the company to implement a dividend payout, which allows shareholders to receive a portion of the company's profits on a regular basis. This can provide liquidity for shareholders who need or want to sell their shares but may not be able to find buyers.
• Offer a buyback program: A company can also offer a buyback program, in which it repurchases some of its outstanding shares from shareholders who want to sell. This can help to increase the value of the remaining shares and provide liquidity for shareholders who need to sell.
• Go public (IPO): Another option for providing liquidity is for the company to go public through an initial public offering (IPO). This involves selling shares to the public, which can provide liquidity for shareholders who want to sell their shares. However, going public can be a complex and time-consuming process, and it may not be the right choice for every company.

It's important to note that each of these options has its own pros and cons, and it's important for the company to carefully consider which option is the best fit for its specific circumstances.

How should a startup founder evaluate a potential venture capital investor?

As a startup founder, it is important to carefully evaluate potential venture capital investors to ensure that they are a good fit for your company and share your vision for the future. Here are a few key factors to consider when evaluating a venture capital investor:

• Alignment of values and goals: It is important to ensure that the investor shares your values and goals for the company, as they will be a significant stakeholder and play a key role in decision-making.
• Investment track record: Look at the investor's portfolio and track record to see the types of companies they have invested in and their success rate. This will give you an idea of the investor's investment strategy and whether it aligns with your company's needs.
• Domain expertise: Consider whether the investor has experience and expertise in your industry. They may be able to provide valuable insights and connections that can help your company grow.
• Network and resources: A good venture capital investor should have a strong network of industry contacts and resources that they can bring to bear for the benefit of their portfolio companies.
• Communication and engagement: Evaluate the investor's communication style and level of engagement with their portfolio companies. You want an investor who is responsive and proactive in supporting the growth of your company.

By considering these factors, you can choose a venture capital investor who is a good fit for your company and will help you achieve your long-term goals.

What is the best advice for a startup founder wanting to raise capital?

Raising capital for a startup can be a challenging process, but there are several strategies that can help increase the chances of success. Here are a few tips for startup founders looking to raise capital:

• Create a compelling pitch: Investors want to see that you have a clear vision for your company and a solid plan for how you will use their funds to achieve your goals. Spend time crafting a pitch that highlights the unique value proposition of your company and how it addresses a real need in the market.
• Build a strong network: Investors often invest in startups through their personal and professional networks. Building strong relationships with potential investors, industry experts, and other entrepreneurs can increase the likelihood of finding potential investors.
• Understand the different types of funding: There are various types of funding available to startups, including venture capital, angel investment, and crowdfunding. Understanding the pros and cons of each type of funding and which one is the best fit for your company can help you make informed decisions about how to raise capital.
• Be prepared to negotiate: Raising capital is a negotiation process, and it is important to be prepared to discuss terms and negotiate terms that are favorable to both you and the investor. This may involve giving up equity in your company, but it is important to find a balance that works for both parties.
• Stay focused and persistent: Raising capital can be a long and challenging process, and it is important to stay focused and persistent. Don't get discouraged if you face setbacks or rejections, and continue to pursue funding opportunities that align with your business goals.

Why is it harder for women and minorities to raise funding?

There are a number of factors that can contribute to the difficulty that women and minorities may face in raising funding. One factor is the lack of diversity in the venture capital industry. According to a report from the National Venture Capital Association, in 2020, just 8% of partners at venture capital firms were women and under 3% were Black or Latino. This lack of diversity can lead to a lack of representation and support for women and minority-led businesses, which can make it more difficult for these businesses to secure funding.

Other factors that may contribute to the difficulty that women and minorities face in raising funding include unconscious bias and discrimination, a lack of networks and connections, and the challenges of starting and growing a business in general.

It is important to note that these challenges are not insurmountable and that there are many successful women and minority-led businesses that have been able to secure funding and achieve success. However, it is also important to acknowledge that these challenges exist and to work towards creating a more equitable and inclusive environment for all entrepreneurs.

How do I know if my startup is considered an impact investable company?

Impact investing refers to investments made with the intention of generating positive social or environmental impact alongside financial return. Impact investable companies are those that align with this goal and are seeking capital from impact investors.

There are several ways to determine if your startup is considered impact investable:

• Consider your company's mission and values: Does your company aim to solve social or environmental problems? Is this a core part of your business model?
• Look at your company's products or services: Do they have a positive impact on society or the environment?
• Evaluate your company's operations: Do you have sustainable business practices in place, such as reducing your carbon footprint or sourcing materials ethically?
• Consider your target market: Are you serving underserved or marginalized communities?
• Research impact investing criteria: Different impact investors may have different criteria for what they consider to be impact-investable companies. Familiarize yourself with the criteria of potential investors to see if your company aligns with their goals.

It's worth noting that impact investing is a growing field and there is no one-size-fits-all definition of an impact-investable company. However, by considering these factors and demonstrating a commitment to creating a positive impact, you can increase your chances of attracting impact investment.

Why do venture investors want your startup to be a Delaware C Corporation?

Venture investors often prefer startups to be Delaware C Corporations for several reasons:

• Delaware has a well-developed body of case law that provides legal guidance for businesses, which makes it easier for investors to predict how courts will handle disputes.
• Delaware has a business-friendly legal environment, with laws that are designed to be flexible and accommodating to businesses.
• Delaware's corporate tax laws are relatively favorable to businesses, which can make it an attractive place to incorporate for tax purposes.
• Many successful startups and large companies are incorporated in Delaware, which can give investors confidence in the state's business-friendly legal environment.
• Incorporating in Delaware allows a startup to take advantage of the state's legal system without necessarily having to be physically located there. This can be especially attractive for startups that are not based in Delaware but want to take advantage of its legal and tax benefits.

If my startup is an LLC when should I switch to a Delaware C corporation?

There are several reasons why you might consider switching from an LLC to a Delaware C corporation, such as:

1. Raising capital: Delaware C corporations are a more common choice for startups that plan to raise capital through venture funding, as they offer more flexibility in issuing equity to investors.
2. Attracting talent: Some employees prefer to receive stock options rather than just a salary, and a Delaware C corporation is a better vehicle for issuing stock options.
3. Scalability: If you anticipate significant growth in the near future, a Delaware C corporation may be a better choice as it has unlimited potential for growth and can issue an unlimited number of shares.

It's important to note that converting from an LLC to a Delaware C corporation is not a simple process, and it may involve significant tax consequences. It's a good idea to speak with an attorney and a tax professional before making the switch.

How should a founder think about investor relations for a private startup?

It's important for founders of private startups to carefully consider their approach to investor relations, as building and maintaining positive relationships with investors can be crucial for the success and growth of the company. Here are a few things to consider:

• Communicate regularly and transparently: Keep your investors informed about the progress and challenges of your company. Be proactive in providing updates, and be open and honest about any setbacks or obstacles you may be facing. IR is not marketing.
• Set clear expectations: Establish clear terms and expectations for your relationship with your investors. This may include things like how often you will communicate, what information you will share, and how you will use their funds.
• Build trust: Trust is a crucial element of any successful investor relationship. Be transparent and accountable, and make sure to follow through on any commitments you make to your investors.
• Seek their guidance: Investors can provide valuable insights and guidance based on their experience and expertise. Don't be afraid to seek their advice and input when making important decisions for your company.

When should a startup seek outside counsel from a law firm?

There are several situations in which a startup may benefit from seeking legal counsel from a law firm. Some common examples include:

1. When forming the company: A law firm can help you choose the best business structure (such as an LLC or corporation) and draft the necessary documents to legally form your company.
2. When raising capital: A law firm can help you negotiate with investors and draft the necessary documents for a funding round, including term sheets and investment agreements.
3. When entering into contracts: A law firm can review and negotiate contracts with vendors, partners, and customers to protect your company's interests.
4. When dealing with intellectual property: A law firm can help you register trademarks and copyrights, and advise you on intellectual property issues.
5. When facing legal disputes: A law firm can represent your company in legal disputes and negotiate settlements.

In general, it is a good idea to seek legal counsel from the formation and ongoing, since making sure you're aware, compliant, and protected is critical to long-term success.

How should a venture-backed startup form its board of directors?

Forming a board of directors for a venture-backed startup is an important decision that can have significant implications for the company's direction, governance, and success. Here are a few key considerations for startups to keep in mind as they form their board of directors:

• Composition of the board: The board should be diverse and include individuals with a range of skills and expertise, such as industry knowledge, financial acumen, and strategic planning. It is also important to consider diversity in terms of gender, race, and background.
• Role of the board: The board should provide oversight and guidance to the company, but should not be involved in day-to-day operations. It is important to clearly define the role of the board and the expectations for board members.
• Size of the board: The size of the board should be appropriate for the stage and needs of the company. A smaller board may be more efficient, but a larger board may provide a broader range of perspectives and expertise.
• Board meeting frequency and structure: The board should meet regularly, and meetings should be well-organized and focused on key issues facing the company. It is also important to establish clear lines of communication between the board and management.
• Board compensation: Board members should be compensated for their time and effort, but the amount and type of compensation should be appropriate and transparent.

Overall, it is important for startups to carefully consider the composition, role, size, and structure of their board of directors, and to regularly review and adjust these factors as the company grows and evolves.

What are the best books for a startup founder to read about raising funding and building a startup?

There are many great books that can help startup founders learn about raising funding and building a successful business. Here are a few recommendations:

• "Venture Deals" by Brad Feld and Jason Mendelson: This book provides a detailed look at the process of raising venture capital, including how to structure deals and negotiate terms with investors.
• "Start with Why" by Simon Sinek: This book discusses the importance of having a clear purpose or "why" behind your business, and how this can help you inspire and motivate your team and customers.
• "The Art of Possibility" by Rosamund Stone Zander and Benjamin Zander: This book provides a fresh perspective on leadership and innovation, and offers practical tools and techniques for expanding your horizons and taking bold action.
• "The Innovator's Dilemma" by Clayton Christensen: This book discusses how established companies can struggle to adapt to disruptive innovations, and provides guidance for how startups can succeed in such environments.

I hope these book recommendations are helpful as well as the entire article.