The capitalization table or cap table is key to a startup and should be understood and managed accordingly. To understand what a cap table is and how to build it, please read my post below which explains some the basics. Also read Brad Feld’s introductory post on cap tables. Gust has some great resources as well to understand how to value your technology startup. If you want to skip to the nuts and bolts of creating a cap table, visit CapShare and give it a spin. You’ll need all the details laid out before you plunge in so that things make sense to you.
The financial responsibilities that come with launching a company properly can be confusing, especially if you have not done it before. In some cases the company is launched and before you know it, you have hit hockey-stick growth and you are surrounded by people that are very knowledgeable and that can take care of the legal and financial aspects of running a company. That is the entrepreneur’s dream. Focus on product and hire other brilliant people to take care of the rest. However, that is not the norm so many entrepreneurs need to learn the basics quickly because as much as you want to, you can’t rely on third party folks to advise you on how to run your numbers. It is key that you understand the financials so that you can make decisions quicker. This becomes extremely valuable once you are negotiating a big partnership or your first big client. If you are seeking the partnership, then it is very likely that you will be dealing with sophisticated business people. Also, the opposite could hold true. Your potential investors or partners might be savvy in other business verticals (that’s why you might be seeking them) but they might not be familiar with what it means to invest in a technology startup and how to do it while minimizing the risk. One of those things is the capitalization table. I will run you through the process that I went through to figure out the cap table for Interesante.com –– hopefully this will serve you as a template to follow or at least a base to start.
CAP Table Basics First.
Who are the founders, how much equity each one gets and what is your employee incentive pool (EIP). This really depends on your company but typically you want to set aside somewhere between 10 to 20% of your total equity to attract new hires to your startup. There’s a great post from Fred Wilson about equity compensation. It reads a bit dated but still has valid points of view. Investors like to see that entrepreneurs are thinking long term and that are realistic about hiring and growth needs.
Equity Incentive Plan.
Think about how are you going to compensate your advisors, employees and partners. What is your plan for advisors and how many are you going to seek and why? Your advisors will be your lifeline to knowledge, VCs, potential hires and business strategy. You need to honor their experience and compensate them with the most valuable asset that you hold, which is your equity. Plus they will be in a position to be paid in equity. Depending on the commitment they are willing to make you can decide on the amount of equity you are willing to pay. Here is a great explanation of how Michelle Wetzler negotiated her compensation and the factors she looked at. Take a look and learn from it.
Think long term and offer a deal that fits within their current workload. It should be firm enough that they pay attention to you but flexible enough to allow for some breathing room. You’ll need to define a contract that you can offer to all your initial advisors. There needs to be a cliff for the initial options to be vested and a long-term commitment should be agreed upon. A contract between 24 to 48 months is reasonable and established on-going meetings. Once or twice a month should be enough.
For your key employees you need to make it worthwhile. Depending on experience and seniority, the range could vary. Keep in mind that anything above 1% of shares will affect your pool in a big way. What you give away needs to be measured against the employee incentive pool and not the total of the company pool. That will give you some constraints and will force you to be more creative.
Beyond The Basics Of Cap Tables.
Fred Wilson has a great post on cap tables. As he points out, the cap table shows you all the major stockholders of the company, major option holders and option holders. It shows all of the classes of stock and how much was paid for them. For each investor, shows how much of each class was bought and how many shares of that class are owned as a result. Total up the cost and shares and then calculate ownerships on a fully-diluted basis (which means you include the options, whether issued or non-issued or vested or non-vested).