Cap table management tips from a startup lawyer: Before, during and after investment

Cap table management tips from a startup lawyer: Before, during and after investment

Author: Caroline Joseph
Read time:  6 minutes
Published date:  March 7, 2024
Managing company ownership properly is crucial, especially ahead of raising venture capital. A UK startup lawyer explains what effective cap table management looks like and how founders can avoid – and fix – common cap table mistakes.

When it comes to fundraising, founders want to dedicate time to pitching their vision while investors are focused on finding the best investment opportunity. None of them want to waste time and energy fixing cap table mistakes that are avoidable from the get-go but can lead to complications as the company grows and adds more stakeholders.

Similarly, a startup lawyer’s ideal client is a founder who has their cap table in order before reaching out for legal services. However, an experienced lawyer will also recognise that many startup leaders – particularly first-time founders – don’t know the equity management rulebook by heart. 

As a partner at Marriott Harrison LLP, Fran Spooner knows a thing or two about what startup lawyers want to see on a cap table and why it’s crucial for founders to manage company ownership properly from the early days – especially ahead of raising venture capital. We sat down with Spooner to understand what effective cap table management looks like, how to avoid making common mistakes and what happens when things go wrong.

Cap table scenarios 

What makes a startup lawyer happy when they’re looking at a cap table? According to Spooner, the most important thing is that the company has a cap table in the first place. “It’s quite often the case that I’ll start working with a business and they don’t have one,” she remarks. 

“For early-stage companies, the cap table doesn’t have to be complicated. Go back to basics,” she recommends. “Show the sequence of events and who owns what, but make sure your cap table is distinctly different from the register of members.” 

As it grows, a company might graduate to managing its cap table on a spreadsheet. To demonstrate the trajectory of the business to date, this version of the cap table could include the founders and their split of the company shares, as well as any equity given to other stakeholders – such as friends, family or angel investors.

However, spreadsheets aren’t really scalable; high-growth businesses are likely to outgrow this model pretty quickly, especially as they reach institutional investment rounds led by venture capitalists (VCs).

“Things are often smoother at Series A and beyond because the cap table is already set up. Typically, investors and their investments are recorded properly by this point,” Spooner mentions. 

This level of organisation is what Spooner calls “the gold standard”. She points out that the most efficient companies are often already using a digital platform to manage their equity.

Healthy habits 

Spooner urges founders to start small with cap table admin. “Build a healthy habit: start with ten minutes a day for each equity-related task.You wouldn’t let a stack of papers pile up in your personal life, so why let it happen in the professional sphere?”

“Without a clear outline of the company’s growth journey, it’s difficult for a lawyer or an accountant to jump in and reverse-engineer the information,” Spooner remarks. Startups in this situation run the risk of appearing less professional to prospective investors. 

“If you have a messy cap table that you’re not consistently updating, you don’t really have a cap table at all,” Spooner continues. “There’s no source of truth.”

Taking care of the details will make it much easier to stay on top of your cap table as it evolves, Spooner suggests. Common slip-ups and missing information to watch out for include:

  • Investors listed as ‘angels’ instead of being individually named

  • No record of the price per share at each relevant event 

  • SAFEs not clearly defined, or labelled incorrectly as convertible loan notes (CLNs)

  • No indication of how a pre-money valuation was reached 

  • An unclear option pool setup

“Founders need to know all this information by heart so that they can sell their company convincingly to investors,” Spooner advises. “If they don’t have total visibility and understanding of company ownership, things get lost in the frenzy of fundraising.”

Repairable damage 

Luckily for Spooner, she’s never come across a cap table catastrophe that has scuppered a deal. “It can be annoying or costly, but everything can be fixed,” she insists.

She offers the example of a founder issuing too many shares to an angel investor and then having to redistribute the equity appropriately during the company’s first institutional VC round.

“This is common for early-stage companies because they don’t know how much to give away,” she says. “Fortunately, VCs often enter the conversation and encourage founders to rebalance things so they can remain sufficiently invested in the business – mentally and financially.” 

Spooner encourages founders to stay positive even if things go wrong, as there’s almost always a workaround. For instance, if you can’t issue shares directly, you might be able to grant them through a share option scheme.

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Common mistakes  

Aside from not having a clear history of company equity, Spooner cites dead equity and option pool problems as other common mistakes she’s seen on cap tables.

Dead equity 

“Dead equity” refers to company share ownership held by individuals who are no longer actively contributing to business growth. For instance, a founder heading into an institutional funding round might review their cap table and notice a list of angels who haven’t invested since the very early days.

“It’s brilliant that these investors are willing to take on high-risk opportunities,” insists Spooner. “However, angels typically have small holdings and don’t want to participate in future rounds, so they’re not really contributing to the evolution of the cap table.”

This can also apply to early-stage advisors. When she asks founders why they issue equity to advisors instead of paying them in cash, the typical response is that they’re short on liquid funds and giving away ownership is easier to comprehend. 

However, Spooner encourages founders to consider the future repercussions of this approach, since a small percentage of ownership at the start of their company’s lifetime could be worth a lot more later on. 

“It’s important to think long term before issuing that kind of equity to someone who has spent perhaps two months advising on one very specific thing,” she emphasises. “As a general rule, founders should keep as much control over ownership as possible.”

Option pool problems  

An option pool is a block of shares set aside so that a company can issue equity to people, such as employees, in the future.

In Spooner’s experience, founders don’t need much convincing to set up an option pool. “They’ll talk to others, get founder FOMO and set up a pool to incentivise their employees.” 

She also observes that startups tend to exhaust the option pool in the early days. It’s only after receiving capital investment and building out their team that founders understand the importance of a correctly established option pool.

Spooner recommends establishing a smaller incentive pool early on, noting that pools at the seed stage typically represent around 10% of total company ownership (on a fully diluted basis). “It might be an administrative annoyance to expand the pool later on,” she says, “but that’s less painful than setting aside too much equity, say 25%, before you even have any employees to issue options to.”

Preventative measures

From the perspective of a lawyer like Spooner, cap table hygiene is a priority. However, it’s typically not front of mind for founders, who are more focused on generating revenue, checking in on staff and growing the business.

If a founder asks for guidance from an expert, Spooner doesn’t see this as a red flag. “Given the state of the current market, I’m working on more early-stage deals than usual,” she says. “There are a lot of first-time founders who have never done this before, so it’s understandable that they might need help.”

Spooner encourages startup leaders not to suffer in silence. “Lawyers are like doctors for your cap table. They can fix mistakes or prevent errors from happening in the first place."

Lawyers and efficient equity management go hand in hand. As your business grows and continues to raise funding, getting your cap in order is one thing, but finding a scalable solution is another.

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Caroline Joseph
Caroline Joseph is a marketing manager at Carta, representing international markets. Prior to Carta, she worked in campaign marketing and communications for a range of businesses, helping to promote tech solutions to global intersectional issues – such as the climate and female health.