Investors

What Do Investors Look for on Your Cap Table?

September 25, 2024

What Do Investors Look for on Your Cap Table?

This is a great question and one worth careful consideration. But first, let’s look at what a cap table tells you. A cap table (or capitalization table) is a document, often in spreadsheet form, that outlines the details of who has ownership of a company. It lists all the securities, the number of shares, and types of ownership interests in a company, including stock, convertible notes, warrants, and equity ownership grants. Some think it’s just a chart showing who owns what in your company. But within that innocuous positioning of numbers and names lies a tale of equity, growth, and the vital signs of a business’s financial health. 

Cap tables offer a snapshot of your company’s current and future ownership, showing how much control the founders retain, how much equity is available for future hires or investors, and what the potential dilution effects are. Understanding this document is not only crucial for founders but also for any investors considering putting their money into your business. A poorly managed or confusing cap table can scare off potential investors, while a clear, transparent, and strategic cap table can attract and reassure them. 

So now that we talked about what is on a cap table, what do investors look for? 
For investors, the cap table is a key due diligence document. They’ll initially want a clear, accurate representation of ownership stakes, such as the allocation of shares among founders, employees, and investors. Once this information is received, they’ll analyze the equity distribution to ensure it aligns with industry norms and fairness. Firms will also assess the presence of any dilution safeguards or anti-dilution provisions that will protect their investment over time. Venture capital firms will consider any presence of convertible securities that can impact the overall capital structure and potential future dilution, including options, warrants, or convertible notes. 

Key Aspects Investors Focus On: 
               1. Equity Distribution: 

Investors scrutinize the allocation of shares to understand the power dynamics within the company. An equity split that heavily favors the founders might indicate a lack of alignment with employees or an unbalanced risk-reward structure for investors. Conversely, too much dilution among founders can suggest they’ve given away too much early on, potentially undermining their motivation to drive the company forward. Investors want to see a balanced approach that incentivizes all parties. 

               2. Anti-Dilution Provisions: 

Investors are highly sensitive to the risk of dilution, which can reduce the value of their stake over time. Cap tables that include anti-dilution protections, such as weighted average anti-dilution provisions, can be more appealing. These provisions help safeguard investors’ shares against dilution during future funding rounds by adjusting the conversion price of their securities in case new shares are issued at a lower price. 

               3. Convertible Securities: 

The presence of convertible securities, such as convertible notes, options, and warrants, can significantly affect a company’s capital structure. Investors assess these elements to understand how they might impact future ownership. For example, if a large amount of convertible debt is set to convert into equity at the next financing round, it could dilute other investors’ stakes, making the investment less attractive. 

               4. Vesting Schedules and Employee Incentives: 

A cap table should include clear vesting schedules for both founders and employees. Vesting schedules protect the company and its investors by ensuring that founders and key employees earn their equity over time, rather than all at once. This aligns incentives and keeps talent committed to the company’s success. Investors particularly favor seeing founder vesting schedules that demonstrate long-term dedication to the company. 

               5. Governance and Decision-Making Power: 

Investors look at the cap table to determine who holds decision-making power within the company. This includes evaluating voting rights associated with different types of shares and any special privileges that may be granted to certain shareholders. A cap table showing a reasonable balance of power reassures investors that the founders and early investors retain enough control to guide the company without being overly vulnerable to new investors. 

               6. Cleanliness and Transparency: 

Investors want a clean, transparent, and error-free cap table. Any discrepancies or confusion in the cap table can be a red flag, signaling poor management practices or even potential legal issues. It’s crucial to keep your cap table up-to-date and accurate, reflecting all transactions, including stock option grants, convertible notes, and any changes in equity distribution. This transparency builds trust and shows investors that the company is well-managed. 

Real-World Scenarios: 
               1. Startup X Raises Its First Series A Funding Round: 

Startup X secures $5 million in Series A funding at a valuation of $15 million. Prior to the round, the cap table shows that the founders held 80% equity, with the rest vested in options and a convertible note. The valuation and investment amount have a direct impact on dilution for the founders and early employees, as well as on the percentage share for the new investors. In this scenario, investors would assess how the new funding round affects ownership stakes and whether the post-money cap table reflects a fair and sustainable equity structure. 

               2. A Merger Deals a New Hand to the Cap Table: 

Company A merges with Company B. The cap tables of both entities need to be reconciled, taking into account any demerger or equity-sharing agreements as per the merger contract. The cap table post-merger will form the basis for future shareholder rights and payouts. Investors involved in the merger will scrutinize how the combined cap table aligns the interests of both companies’ shareholders and whether it creates a balanced and scalable ownership structure. 

Common Mistakes to Avoid: 
               1. Over-Granting Equity Early On and “Dead” Equity: 

One of the most common mistakes founders make is giving away too much equity too soon, often to early employees or advisors who may not provide continued value to the company. While it’s important to attract top talent, over-granting equity can leave founders and key team members with little incentive if the company grows and requires further dilution. A carefully managed cap table should reflect staged grants and vesting schedules that reward long-term commitment. 

               2. Ignoring the Impact of Convertible Debt: 

Convertible debt can be a useful financing tool, but it also comes with potential pitfalls. If not carefully managed, a large amount of convertible debt converting at a low valuation can unexpectedly dilute existing shareholders. It’s essential to model the impact of these conversions on the cap table ahead of financing rounds. 

               3. Lack of Regular Updates: 

Your cap table is a living document that should be updated regularly, not just during fundraising rounds. Any issuance of stock options, the conversion of convertible notes, or changes in equity due to acquisitions should be promptly reflected. Regular updates ensure that you always have an accurate snapshot of your ownership structure. 

NASPP Resources

Selecting the right cap table solution is a strategic decision that can significantly impact your company and it’s not an easy thing to do, especially when the market has gotten considerably more competitive.

Newer providers and existing ones have all been working to create more robust solutions for their clientele to help ensure that they can manage their equity structures effectively. To see what innovations have been made and what options are currently available, please check out the webinar below to take advantage of the unique opportunity to experience the 12 best-in-class cap table providers demo their platforms.

  • Kelly Nedier
    By Kelly Neider

    Sr Vice President, Head of North America Sales

    Astrella