Quora Answer: What Mistakes Do Startups Make with Their Capitalisation Table?

The following is my answer to a Quora question: “What mistakes do startups make with their capitalisation table?” 

The capitalisation table shows the equity capitalisation for a startups or any early-stage business.  Properly done, it is a detailed breakdown of a company’s current shareholders equity, and planned equity for future shareholders; as well as the various categories of equity, whether ordinary, preferred, convertible, and others. 

When it comes to startups, the main problem with the capitalisation table is either giving up too much equity too early, or an unwillingness to give up equity when it is necessary.  The latter is easily addressed through negotiation, while the former is a lot more difficult to fix. 

For example, it is extremely unwise to give up equity to staff at in the early stages of a startup.  If the business takes off, that equity given up may have been undervalued, and complicate further fund raising series. 

For example, we could have a situation where an early investor, likely a wealthy family member, gives a significant sum for a large stake.  This complicates further fund raising because it means any further stakes are already overvalued, and would deter further investors until this is cleaned up. 

For example, we could have a situation where even before we reach series A funding, the founders have given up so much equity that any further stake would further dilute their holdings, and complicate further deal making because there are too many decision makers who are not directly important to the venture. 

In summary, as we go further down the funding scale, the value of a stake changes drastically, depending on many factors, from the timeline of exit, to the business environment, to poorly worded contracts on vesting rights.  These are strategic problems, and may require significant internal negotiation to fix, or failing which, the abandonment of the entire venture. 

Aside from these, there are the administrative mistakes that bedevil many startups, because founders are not often people verses in actual business administration and development.  They are people with a great idea who have the time and perseverance to try and bring it to market.  As such, we find the usual mistakes in the wording of the contract, errors in the calculation of the table, errors in the shareholder details, transactional errors, and even contracts that contravene laws.  Administrative errors are a pain to fix, but they tend to be simpler to address than the strategic errors, which can be fatal for future funding ambitions.