I don’t see too many cap tables these days, as most of my startups are at day one. Many don’t even have a founder’s agreement. However, when you plan to raise capital you need both a founder’s agreement and a cap table. The cap table will be the financial document for the life of your company.
Cap table is short for capitalization table. I’m not a finance guy and have always either had one as a co-founder or used an on-call CFO to help me with financial instruments like the cap table. So this post is far from a tutorial, But if you need a tutorial here’s one from Medium I can recommend. I just want to accomplish two things: one, make you aware of the need for a cap table, and two, provide a few tips about cap tables in general.
First of all dividing up equity amongst founders is a very hard task and can be fraught with problems. Most founders and even early employees take no salary at least until they raise capital – it’s what is called “sweat equity.” That is ownership in the venture earned by your efforts. The classic problem you will run into here is the “But it was my idea!” claim. Typically one founder may come up with the big idea for the venture and then brings on another founder or more to help executive it. If you have been following this blog or one of the hundreds of other sources of information about startups you’ll know that most of us in the entrepreneurial ecosystem believe that execution is far more important than the idea. The common wisdom is that “ideas are cheap.” That may be true but with no idea there is no company. So I believe that whomever brings the idea should get some additional equity. However, companies very often pivot away from the founding idea and I’ve never heard of a founder having to give back some of their equity because the venture ended up pursuing a different idea! That common scenario helps to bound the problem. It’s up to the founders of course, but my advice is to allocate a modest amount, say 5%, additional to the founder with the idea.
The second problem has to do with those who are not full time on the venture. This is very common amongst academic startups, not so common outside academia. This is a complex situation which needs to be handled on a case by case basis. The best way to treat a part timer is to pay them and not issue any equity until they join the company full time. But this often is not possible as raw startups lack the capital. Equity venting schedules often have a one year cliff. In other words the employee gains ownership of the stock over four year period, but no equity is earned until the first year completed. The goal of this is to prevent people from leaving the company before they put in at least a year’s work. After the first equity can be earned on a month to month basis. You can use the equity cliff device with part timers. Grant them a small amount of stock options if you must, but decide on what they would get when they join full time. Then set a period – at maximum a year – for them to join full time.
Once you have settled the worth of the idea and how to handle founders who aren’t working full time on the venture, the next common issue is setting aside equity for future employees and possibly for advisors. Ventures commonly start with about 15% to 20% in the equity pool, realizing that like other stock holders, the pool will get diluted by investors. I often advise founders to set up a strategic advisory board and to allocate about 2% of the equity for the board.
Finally comes the most difficult task of all: dividing up the remaining equity amongst founders. While 50/50 is ideal, and I’ve known founders who while deserving of more than 50% settled for that amount to avoid friction, that’s hard to do when you have more than two founders. But try to keep things simple, which will result in a so-called “clean cap table.”
Keep in mind that a cap table is a living document, it needs to be maintained carefully for the life of the venture. It is one of the first things a prospective investor will ask to see. Sloppy, out of date, or inaccurate cap tables can turn off an investor very quickly. One way to make sure your cap table is set up and maintained correctly is to use an outside service like Carta. Carta was founded in 2012 to help private companies manage their cap table by eliminating spreadsheets and paper certificates. It now provides a variety of other related services.
When the press writes about the glory of startups they omit the hard and dirty work like creating and maintaining the venture’s cap table. But as a founder you don’t have that luxury. The sooner you tackle the twin tough tasks of the founder’s agreement and the cap table the better. An ounce of prevention is well worth a pound of cure when it comes to these essential founding documents.