Cap tables are one of the most critical documents used as part of the fundraising process. As they serve as accurate records of your startup’s most recent ownership structure, it shouldn’t be surprising that they hold vital information that investors need to make a decision.
In our article, we’ll walk you through what potential investors look for. Specifically, we’ll cover:
The importance of cap tables from the perspective of an investor
What can go wrong if you have poorly maintained cap tables
What investors specifically look for along with a free checklist
Why cap tables matter for investors
Cap tables – provided they’re properly maintained – give readers valuable insights into the deeper workings of your startup. From the point of view of a potential investor, cap tables:
Depict the balance of power in a startup
Ownership is power. As cap tables depict who knows what and how much, it clearly paints a picture of the balance of power within a startup. Perhaps a startup has a balanced distribution of ownership, or maybe it could be skewered more towards being founder or investor-controlled.
Regardless, by understanding this, investors can find out more about the startup’s governance and decision-making processes so they can decide whether to invest.
Startup’s financial health and growth potential
Beyond ownership structures, detailed cap tables can provide investors with a general feel for your startup’s room for growth and financial health.
From depicting a snapshot of your startup's ownership to your capitalization history, dilution, and a rough estimation of your startup’s valuation, information like this can be used by investors to ensure your startup is healthy and has the potential to thrive.
Helps investors with risk assessment
Overall, cap tables with all the information they provide, help potential investors assess whether or not investing in your startup is appropriate for their risk appetite.
From understanding how ownership is concentrated to assessing whether dilution is acceptable and more, all these factors play a significant role in a potential investor's risk assessment.
Consequences of a poorly maintained cap table
Given the importance of cap tables for the decision-making process, startups absolutely cannot afford to provide investors with inaccurate cap tables. The stakes are high as this can lead to:
❌ Confusion and misunderstandings
Inaccurate cap tables, whether by design or neglect, can confuse potential investors and, at worst, mislead them into making poorly-informed decisions. For example, inaccurate cap tables can cause investors to overvalue a startup (e.g. via inaccurate ownership percentages), which may help secure investment in the short run but will inevitably lead to serious disputes in the long run.
❌ Reputational harm
Trust is one of the most important things investors look for in a startup. If investors cannot trust you to deliver and provide accurate information through your cap tables, it stands to reason that they cannot trust you to manage millions as capital. Poorly maintained cap tables damage your credibility and reputation, erode investor trust, and potentially scare away other potential investors.
What investors look for in cap tables
While clean, well-maintained cap tables are a top priority for investors, this is just the tip of the iceberg. On a deeper level, when reviewing cap tables, investors tend to pay particular attention to:
1. Dead equity
Dead equity is a huge red flag and can easily scare away potential investors, from angels to institutions. Dead equity is equity that is owned by individuals, such as founders, employees, or investors, who no longer play an active role in supporting your startup.
Because equity is often used and seen as an incentive for supporting a startup, dead equity holders pose a problem as it’ll dilute the overall value of their investment. To get around this, either carefully plan ahead in regards to who you’re giving equity to or consider buying back dead equity before fundraising.
2. Impossible scenarios
Cap tables have to be grounded in reality as this indicates to investors that you’re financially savvy and have adequately prepared. For this reason, it’s critical that your cap table doesn’t contain any impossibles. In comparison, minor, genuine mistakes such as inaccurate shareholder information, though not ideal, would be far more acceptable and less embarrassing.
Impossibles include serious mistakes that aren’t logical like
shareholder ownership being listed as more than 100%,
securities granted to non-existent individuals,
and even instances of negative equity or debt.
3. Effective option pools
Option pools are a powerful way to attract and retain employees. Well-implemented option pools strike the right balance between giving up equity and setting up a startup for success, and oftentimes, signal to investors that your startup has its eyes on the long-term and is composed of a highly motivated team.
Likewise, a lack of option pools on your cap table can signal that your startup
may not be focused on long-term growth,
could face challenges in hiring and retaining talent,
and may experience dilution in the future if an option pool is created (as they often are).
Time is valuable, especially for potential investors who are likely considering countless other startups. Because of this, it is crucial that your cap table is clean, well-organized, and provides a clear picture of your startup's ownership structure to anyone who reads it.
Moreover, organized cap tables can demonstrate that your startup is capable of managing important financial and legal matters, showcasing your attention to detail and commitment to good governance. This can instill confidence in investors that your startup will use allocated capital responsibly.
Maintaining proper and accurate cap tables is crucial for startups seeking investment. By understanding what investors look for and ensuring the integrity of your cap table, you can increase your chances of attracting investment and building trust with potential investors.
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