The Startup Founder’s Guide to Cap Tables and Venture Capitalists
If your startup were a Netflix series, the cap table would be the credits rolling at the end of each episode. For any up-and-coming founder, it’s crucial to have a detailed understanding of who owns what at each stage of the business. This is true whether you’re doing diligence for raising money or simply incorporating a new business.
The capitalization table, or cap table, provides the information you need for a clear understanding of your company’s ownership. In this post, we’ll dive into what a cap table is, and how to use it.
What is a cap table?
A cap table, or capitalization table, is a chart typically used by startups to show ownership stakes in the business. It lists your company’s securities (i.e., stock, options, warrants, etc.), how much investors paid for them, and each investor’s percentage of ownership in the company.
A cap table is the place of record for the equity-based transactions of a company. It includes ownership stakes, types of shares, and option pools. Ownership stake refers to who (founders, investors, or employees) owns what amount of the business. This reflects who has control over the company. Since most startups need voting agreement among both common and preferred shares, this view shows who needs to sign off on major company decisions (e.g., company sale or reorganization).
The types of shares indicate who has common shares with no special treatment, versus who has preferred stock. Preferred stock typically can often be converted to a 1x payout of money invested. This “money-back” provision protects investors in the event of a sale at a lower valuation.
Debt that can convert into equity is the other type of transaction often found on a cap table. This convertible debt is factored into all ownership calculations on a fully diluted basis. Calculating on a fully diluted basis is a way of looking at ownership where all outstanding warrants, options, and convertible notes are exercised.
Cap Table Template
Here’s a sample cap table:
As the columns move from left to right, additional dilution items are applied to get an understanding of a person’s true ownership percentage of the company.
You’ll notice the cap table lays out the essential pieces of a transaction:
- Shareholder name as it appears on the security
- Date of issuance
- Number of shares or units issued
How to Use a Cap Table
1. Understanding your equity
One of the primary uses of the cap table is to show how decisions impact the equity structure of a company. Do you want to expand the employee option pool? Are you raising another funding round?
Either way, you can see exactly what impact that will have on your shareholder groups. When you’re raising funding for the first time, you need to know exactly what you’re giving up. The cap table will do just that, and show you the proposed new structure of the company.
2. Initial equity distributions
When creating a new company, the cap table is where you put the company breakdown in writing. Discussing initial equity distributions is difficult, but it’s a conversation that needs to happen at the formation of every business. Outline distributions to the founding team — and use the cap table to facilitate the conversation on day one.
3. Managing employee options
When hiring new employees, you want to align their incentives with the objectives of the company. Stock options are a great way to do just that. It gives you a way to match an employee’s contributions with the appropriate amount of stock.
The cap table shows exactly how many options are authorized or available to be issued at any given moment. It also lists the number of options used to date. When creating your cap table, you’ll want to ensure you have enough options to cover a 12-month rolling period.
4. Term sheet negotiation
Having a clear snapshot of your company’s ownership structure enables you to run a what-if analysis on a financing round. Look at what happens to your ownership stake and company control at different valuation levels, and evaluate other factors such as if new options are issued before or after financing. This gives you insight into what situations you’re happy with and where to draw your line in the sand.
A cap table isn’t a legal document, but rather a snapshot of ownership information used to make decisions. Understanding the information it contains and common ways to use it will guide you on your path — and make your next big fundraising decision or employee hire a little easier. So, whatever type of episode your startup turns out to be, don’t forget to write down the credits.
To learn more about startup success, check out these growth hacking resources next.
Originally published Nov 23, 2018 7:30:00 AM, updated November 23 2018
The Entrepreneur’s Guide to Venture Capitalists
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There’s no doubt about it — startups are expensive. If you’re looking to validate a market, prove out a pricing model, or put together the right team, you’ll need resources. Time and money are the most common resources for startups — and the more you have of one decreases the amount you need of the other.
Businesses with a small burn rate often don’t require much funding to get started because they’re cash efficient. Those pursuing massive opportunities in a competitive space are fighting for every second on the clock.
If you’re in need of funding, one option is to work with a venture capitalist. But, what is a venture capitalist? And is it the right funding option for you?
What Is a Venture Capitalist?
A venture capitalist (VC) is an investor that works with high growth potential startups. They can get you access to resources and know how to grow your business on the fastest scale possible.
Venture capitalists invest outside equity from professionally managed pools of money. This isn’t your uncle Bob writing your business a check for $10,000 — this is someone who invests in new startups every day.
The funds come from a group of limited partners (LPs) from whom the initial fund was raised. And the total amount raised by a fund often tells you what type of investment stages they’re interested in.
However, a VC is more than a check, at least a good VC is. Venture capitalists are partners in your venture and while they provide you with a check the most value they can bring to the table is their know how.
Venture capitalists work with a lot of businesses and are good at pattern matching, identifying issues other businesses have faced, and recognizing when you’re experiencing a similar issue. A venture capitalist often sees hundreds of businesses every year and works closely with a handful of them.
This gives them experience in founder dynamics around managing conflict, scaling a team with various sales channels, and ultimately how to take your business from point A to point B. This is why companies that are looking to go far and go quickly often need to take the venture capitalist route.
Venture Capital Firms
Depending on where your startup is based you may have different options available to you for connecting with venture capital funds. Here is a list of top funds in the U.S. grouped by region:
Region: East Coast
Noteworthy investments: Lessonly and Workfront
Openview works with companies of all kinds to help with their expansion stage and go-to-market strategy. With over $5 billion under management, their portfolio includes more than 200 companies in technology and healthcare.
Region: East Coast
Noteworthy investments: LinkedIn, Pinterest, and Twitch
Bessemer works with early-stage companies in the consumer, healthcare, and enterprise industries and are there every step of the way thereafter. They helped one portfolio company bring in $25 million in new pipeline and $5.9 million in closed-won deals after building out their BDR team.
3. Union Square Ventures
Region: East Coast
Noteworthy investments: Quizlet, Soundcloud, and Kickstarter
Union Square Ventures works with larger companies who have successfully established an engaged user-base. Since 2004, they have invested in over 100 companies, spanning different sectors and geographies.
4. First Round Capital
Region: West Coast
Noteworthy investments: Beautiful AI, Birchbox, and Mint
First Round Capital is called First Round for a reason — they work with seed, pre-seed, friends and family, angel, or anything in between. They don’t have a specific industry focus or sector.
5. SaaStr Fund
Region: West Coast
Noteworthy investments: SalesLoft and TalkDesk
SaaStr Fund works with four to five up-and-coming companies per year, investing anywhere from $1 million to $5 million per deal. They only invest in companies that are a part of the SaaStr.com community.
Region: West Coast
Noteworthy investments: Airbnb and Dropbox
Sequoia started partnering with companies early and at every stage of growth in 1972. The founders of the companies they’ve invested in now have an aggregate, public market value over $3.3 trillion.
7. Matrix Partners
Region: West Coast
Noteworthy investments: Hubspot, Quora, and Zendesk
Matrix Partners works in early-stage investing, backing founders building companies across B2B, infrastructure, and consumer technology. They’ve invested over $4 billion and have had over 110 profitable acquisitions.
8. Hyde Park Ventures
Noteworthy investments: G2 Crowd and Shipbob
Hyde Park Ventures funds early-stage technology companies in the Midwest. They focus on investing in technology companies with B2B SaaS and consumer marketplace business models.
9. Matchstick Ventures
Noteworthy investments: Inspectorio, Branch, and Upsie
Matchstick Ventures invests where innovative ideas, huge markets and, most importantly, diverse founders strike. They’re honored to support “underdog” founders who will stop at nothing to succeed. Matchstick exists to act as a catalyst for our founders, our partners, and our startup communities.
10. Foundry Group
Noteworthy investments: Techstars and Yesware
Foundry Group focuses on Seed and Series A investments in technology companies throughout the US and Canada. They’re thematic investors looking for new businesses along certain problem or theme areas.
Venture Capital Funding
A venture capital funding is a financing event where the lead investor is a venture fund. The lead investor sets the terms of the round with the company and acts as the primary negotiator. They set the valuation of the business before the infusion of capital (the pre-money valuation).
In a venture capital funding, the lead investor is often the investor that contributes the most money for the funding round. They oversee the negotiations and formalities of the round like determining board structure and employee option pool availability.
Having a venture fund lead your financing round dramatically increases the speed and likelihood of closing the round.
How to Get Venture Capital
There are no silver bullets when it comes to startups but there are a few things you can do to improve your odds of securing financing.
- Be prepared before you try to get money.
- Have your materials ready.
- Pick the right amount to raise for your round
1. Be prepared before you try to get money.
Every company, even early-stage companies have the ability to de-risk the business to some extent. For example, you could build a prototype of your software to show its feasibility and get feedback until you’re ready for pre-sales of your product.
The point here is you should try to de-risk the business as much as possible. Validate that your technology is feasible and that your customers want it, and suddenly the investment starts to feel like more of an opportunity and less of a handout. Examples that de-risk your business:
- Early customer traction or pre-sales: sales are made before the initial product launch
- Product readiness: your product is closer to a beta or 1.0 launch than a prototype
- Operating history: the ability to demonstrate running the business for a period of time
- Team composure: having all the main functional areas covered in-house, tech companies need tech people and business people
2. Have your materials ready.
The main material in most early-stage financing conversations is your investor deck. A good deck will communicate what you do in 30 seconds, explain the problem clearly, show your solution from a high level and with a demo, and finally dive into traction, differentiation, and the market opportunity you’re pursuing. There are several ways to present this information for maximum effect. For more information on how to put together your early stage investor deck take a look at these sample templates from Techstars.
The other key material that’s often overlooked in financing is your investor pipeline. This is typically a spreadsheet or CRM pipeline that lays out who you’d like to talk to, why you’d like to talk with them, and key details behind their fund (amount raised, average check size). You’ll want to do your homework here to include only funds that invest in companies like you at this particular stage. Meeting with investors who only do consumer investments when you’re a B2B, or who only do B round deals when you’re raising a seed just won’t cut it.
3. Pick the right amount to raise for your round.
What’s in a number? If that number is the amount of money you’re raising, then an awful lot. For example, your fundraising number shows how you’re thinking about how long you have until you run out of cash, when you’ll need to fundraise again, and how far along you are in your funding journey. Seed stage companies that set out to raise $1.5 million or more wound up hitting that number less than seed stage companies who set out to raise only $750,000.
In picking the number for your round you want to have a number that provides a reasonable amount of runway, but also a number that lets you build momentum around your investment quickly.
Angel Investor vs. Venture Capitalist
Angel investors are individuals that invest in startups. Unlike venture capitalists that deploy funds on behalf of their limited partners, they invest their own money. Angel investors play a large role in the early-stage financing process, and many are successful entrepreneurs and supporters of the startup ecosystem.
The benefit of working with an angel investor, if they’re relevant to your market and product, is they can provide relevant advice and make solid connections with other investors. Every startup community has some sort of angel investor presence. These are folks powering a lot of early deals but don’t confuse them with venture capitalists.
When working with angels, ask them about other companies they’ve invested in. Some angels are great at working with other companies, while some aren’t so great. By backchanneling with other founders and community members you can find out exactly who you’re talking to. In having these types of conversations it is good to talk to both founders that have gone on to be successful and others who haven’t. This way you’ll know who has your company’s back when times are tough.
The last note around angels is that they often times do not have minimum investment requirements. This does not mean that you should not have a minimum investment requirement. Raising $500,000 off of $10,000 checks will drain your time and energy so much that your business will come to a screeching halt. Setting minimums on your financing round shows investors, both VCs and angel investors, that you value your time and take yourself seriously.
If you’re looking to not only go far but also go quickly, then venture capital might be the route for you. If you have a big market opportunity, a good team, a stellar product, and the willingness to put in the work, you might be right for it. With new ventures, everyone starts at zero, success is just a matter of how quickly you level up. To learn more about startups, read about startup burn rates next.
Originally published Jan 25, 2019 8:30:00 AM, updated January 25 2019
Startup Burn Rates Explained in 500 Words or Less
It’s tempting to write off “burn rate” as cute startup jargon or a funny subplot on the television series “Silicon Valley.” But a correctly calculated burn rate is crucial for the responsible growth, planning, and success of a business.
In fact, 82% of small businesses fail because of cash flow problems. But what exactly is a cash burn rate and how do you calculate it? I’ve got the answers for you below.
What is cash burn rate?
Cash burn rate, or negative cash flow, is the pace at which a company spends money — usually venture capital — before reaching profitability. It’s often calculated by month (e.g., a startup with a burn rate of $30,000 a month is spending $30,000 a month) and is spent on overhead expenses.
A company’s gross burn is the total amount it’s spending on operational expenses each month (with the absence of positive cash flow). In our example above, a startup spending $30,000 a month on staff salaries, office space, and a cool new ping pong table would have a gross burn rate of $30,000 per month.
Let’s say, however, this company is also generating $5,000 a month in revenue. To calculate the net burn rate, you’d subtract $5,000 from $30,000 for a net burn rate of $25,000 per month.
How to calculate your burn rate
To identify how long your company can burn cash before needing to turn a profit (i.e., running out of cash), divide the amount of cash you have left by how much you spend every month (i.e., the cash you burn). If you burn $25,000 per month and have $100,000 left in reserves, you have four months of runway left.
Most investors and entrepreneurs recommend having at least six months of runway available at all times. That means if your burn rate is $25,000 per month, you’d want to have at least $150,000 in available cash.
This ensures that if there’s a temporary market downturn, a problem with one of your product releases, or an unexpected expense, you’ll be able to handle it without threatening the health and success of your business.
Originally published Oct 12, 2018 7:30:00 AM, updated October 12 2018
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