Keep your cap table clean
7 min read

Keep your cap table clean

Keep your cap table clean

Cap table problems are one of the worst problems you can have as an entrepreneur. Mess up your product, you can fix it. Mess up your launch, you can launch again. Mess up with the press, you can make sure the next article is better. Lots of things in startups are actually pretty fail-resistant.

But if you screw up your cap table, it’s incredibly hard to fix it. That’s because the cap table is linked to two key things: emotions and taxes.

Every entrepreneur learns the hard way that once things are moving, you can’t freely exchange shares — even among yourselves as cofounders. No matter where you live, the government believes there’s a value to your shares, and it isn’t zero.

So if you decide at some point that someone received too few shares, or someone has too many shares, it can be very hard to balance things out. Plus, as soon as you have an investor in your cap table, you’ll have what’s known as a market price for the shares.

(By the way, before we get started, if you do get into trouble, get a good lawyer. When it comes to the cap table, a good lawyer is like a good doctor — they can’t be replaced by a quick Google search. If you get cancer, go see a doctor. If you have a cap table problem, go see a lawyer.)

But instead of having problems, try to get things right from the beginning.

Phase 1: Co-Founders

At The Family we’re pretty convinced there’s only one good way to split equity among cofounders: equally. There are lots of good reasons not to do that. But if those reasons make sense, it actually means the cofounding team doesn’t make sense. You can’t solve problems in the cofounding team by creating an unequal cap table.

Your founding team should be super strong from the beginning. You split equity equally because you think everyone will have equal value over time. That’s the basis for a great team.

I promise, if you have a cofounder who has 70% because it’s their idea, and the two other cofounders have 15% each, at some point people are going to regret their decision. Remember, the cap table is very emotional. When you have a cofounder who wakes up and feels angry about how much they have, they’ll start doing everything they can to tank the company (sometimes even without knowing that they’re doing it).

You, watching them at work, day, after day, after day…

In fact, if you have a cofounder who you don’t want to split equity with 50/50, you’d be better off as a solo founder. Sure, statistically solo founders have a lower chance of success than multi-founder teams. But solo founders are better than unequal cap tables where the cofounders don’t respect each other as equals.

The flip side of this is that if you give equal ownership to someone who doesn’t deserve it, that will kill your startup too. Equal ownership isn’t a magical formula. It’s a principle that forces you to face any mistakes you might be making in your cofounding team.

Who you’re building with is much more important than what you’re building. Being obsessed with an idea causes people to make horrible cofounder decisions. What you’re building will change. But the people you’re building with are going to be there until the end. And if you do get into a founder split, it’s like a divorce times ten. It has all the emotional aspects of a divorce, but without any shared intimacy that can possibly help you.

Phase 2: Your First Investor

The longer you wait for an investor, the higher quality investor you’ll find. The more you achieve without them, the better position you’re in. You’ve been on the market for a month? You’ll have a pretty average level investor. You’ve been out there for a year? The investor quality will be higher.

At the end of the day, you’re going to lose 20–25% of your business in your first round. So you can lose that 25% to a crappy angel investor who’s trying to optimize their taxes, or you can lose it to a seasoned investor who actually knows how to add value to your business. On paper, it’s the same 25%. But the effect on your long-term success is huge.

It comes down to this: don’t let jerks into your cap table.

Once they’re inside, they do what they want.

The good thing about jerks is that they don’t really hide it. Nice people sometimes hide how nice they are, but jerks are pretty open about it. You know it when you first meet them. But as an entrepreneur, you can lie to yourself, thinking it’s more important to have the money than to worry about them being a jerk. It’s not.

In startups, you never need the money. If you run out of money, operate without it. Need to pay rent? Go live with a friend. Need money for food? Eat at your parents’ house. If you don’t have any friends or parents, ok, you might be one of the few people who need to raise money. Mostly though it’s a comfort and ego thing: we all want to tell people we’re successful, and raising money is a great way to be able to do that.

That idea sticks because we read lots of articles about how much someone raised, but not much about who they raised it from. The total is an easy metric, but you have to look beyond the amount.

Plus, after you raise money, you spend money. Now you’ve got a big cash burn that becomes a serious liability. If you have a bad investor, they’ll make your life hell because of that burn.

The easiest way to avoid problems? Founders need to actually ask people about their potential investor. Call 5 people who took money from them. Ask how things went. But so few entrepreneurs do that, mostly because they’re scared of hearing the answer they already know in their heart.

Phase 3: Time Goes On

If you screw up your cap table early, you’ll never get good people on board later on. Why? Because good people never want to be involved with bad people.

One of the secret reasons that investors have for saying “No” to a deal, which they’ll never actually admit to you, is that they don’t want to do a deal with the jerks you already have in the cap table. It’s not a personal thing — it’s that a good investor doesn’t want to validate bad investors by being associated with them. It would send the wrong signal for them personally. So even if they like the project or the entrepreneurs, they can’t do the deal.

An entrepreneur might try to counterbalance a bad investor legally, trying to use a shareholder agreement to keep the bad investor from having any real influence. But here’s another secret: those legal documents have no value.

If a bad investor wants to call you three times per day, there’s no document that will stop them. (And by the way, the worse someone is as a person/investor, the better they are at doing exactly that kind of thing. Wasting their time being annoying and going after others is one of the big characteristics of bad people.) Good people spend time on good things; bad people’s only goal is to go after others.

Bringing an investor into your cap table isn’t just a money thing. It’s a DNA thing. They’ll have a huge influence on who’s whispering in your ear. Founders always think they’re strong enough to make their own decisions. But nobody is strong enough to not be influenced by what the people around you are saying all day long.

If you have people affecting your company DNA who are less ambitious than you, you’ll become less ambitious. And bad investors are always less ambitious than entrepreneurs.

The quality of investors should always win out over money, valuation, anything. That’s why great investors get a discount when they invest, because everyone knows that they’re great and that they’ll positively impact the value of the company.

(Possible) Phase 4: Oops

What happens when you made a mistake in Phases 1–3?

If you have someone around who shouldn’t be there, cleaning your cap table has to be a priority. When you’re raising a new round, find a way to get the bad element out. Clean the cap table with every round. Don’t be cheap, either — give them a good deal. It was your mistake, it’s your responsibility to clean it up properly.

Part of the problem now is that the startup world has started disrespecting money. There’s so much of it from so many investors that everyone sees money as cheap.

And it’s true that before you sign a deal, you can be harsh, you can be cocky, you can do what you want. But as soon as you’ve made the deal, you have to respect whoever invested. They chose to give you money, which means they aren’t giving that money to someone else. Respect that. Don’t take money from someone, knowing it’s a bad idea, and then act like it’s their fault that they’re bad.

Like my mom always said, “Never hurt anything you can’t kill.” (My mom’s awesome.) Once an investor’s in your cap table, you can’t kill them. So don’t think that you can hurt them, either.