18 Truths Your Cap Table Tells Investors
What is a Cap Table, and Who Uses It?
I have seen thousands of deals throughout the years as an Angel investor and mentor to start-ups. The capitalization table is a useful tool for investors and business owners. In short, it is a breakdown of the company's shareholder's equity. Here's an article that explains the cap table a little more in depth. My goal here is to demonstrate what a capitalization table tells investors. These are insights you need to know if you own a business also.
I have learned that the cap table (capitalization table) reveals a great many things to savvy investors. This week I studied three different cap tables to discern situations and discover facts. This led me to muse about past cap table lessons.
The discerning investor can tell the following trends and signals about your business by studying your cap table. Even in the absence of a financial statement, minute book or business plan, the cap table speaks clearly.
The 18 Truths of the Capitalization Table:
- The timing of investments and frequency can signal the rate of progress or “traction”. Investors often compare this to the claims of traction asserted in pitch decks to test authenticity.
- Valuation can often be ascertained quite accurately by reviewing the number of rounds and the percentage gain in each round.
- An upcoming down round or too high an initial valuation are both easily determined by non-standard or aggressive price differences between rounds.
- Overly aggressive up-rounds are instantly observable by their large percentage gains when combined with few takers.
- A look at the friends and family early investors (comparing their percentage ownership to that of founders) signals their degree of support or belief in the merits of a deal. Symbolic or token investments stand out in stark contrast here.
- The use of multiple classes of shares sends a clear signal of the unwillingness of founders to share the same level of risk as other investors. It warns investors, in some cases, to beware an isolationist or greed factor.
- The use of voting and non-voting shares can indicate real or potential founder misalignment, family conflicts, and future governance issues. It can also signal future strategic direction problems.
- A too high percentage of staff/board shares can suggest a future problem with cash flow. It can portray a lack of knowledge on the part of founders about how investment really works.
- Absence of shares for an advisory board or a governing board can indicate a problem of “coach-ability”, an unwillingness to seek external advice, or a delayed move to standard governing structures and processes.
- A key or lead investor (perhaps a super-angel) will often attract smaller investors around the same time, which is a good signal.
- A multiplicity of small investors spread over a lengthy time period may signal either slow growth or problems with traction, or even poor sales efforts.
- The proliferation of many small shareholders such as those in a crowd-funding round can signal a social benefit or a social enterprise component that may assist in future valuation. At least it may signal market support for a cause.
- The absence of anti-dilution shares may signal a capital problem or even future potential of a dispute if a down round were to occur.
- Valuation is aided by a quick mathematical calculation to check if more than, say, 30% of the company has been given away in a particular round of financing. Such a pattern could trigger a future crisis if a founder is eliminated too early or if other early investors are eliminated too soon. The risk of lawsuits or other roadblocks to decision may increase.
- A clean cap table with distinct upticks in value at each round, with well spaced rounds and quick closes, within a reasonable time period such as two to three years, are all signs of a well run business with great traction and high potential for an exit at a great multiple.
- A cap table with 5 to 7 years worth of share purchase dates is a sign of potential lethargy or even an inauspicious finish. The ideal cap table history is 3 to 5 years to a great exit.
- The percentage of debt instruments to equity shown in the cap table can be a sign of trouble. A high percentage may portend a future dispute between debenture holders and equity holders. A low percentage may signify a cash-starved business, with a possible credit crisis or a bank-financing crisis.
- An excessive number of share classes will inevitably signal conflict when a VC arrives on the scene or when an IPO occurs. It also raises suspicions about founder motivation.
CAUTION: These signals are useful to the savvy investor. Yet they are not necessarily guarantees of any kind. Caution is expected. Schedule a free phone call with me by clicking on "Book a free intro call" on the home page of The Catholic CEO website. if you need help with your investments or business.