Managing Round Construct & Cap Table

This article is part of a larger series on Deal Closing. Click here to access all our modules.

3.1 What is a Cap Table?

Simply put, a cap table is the list of all shareholders in a company – it mentions the legal name of the investor, the number of shares they hold (there could be multiple classes of shares), and their percentage shareholding in the company

Whenever you raise funds, there are changes to the ownership structure of the company and so, the cap table needs to be updated accordingly.

3.2 Constructing the Round

To walk you through the playbook, we have created a functional resource for you in this Excel tool.

💡Shreyans Salecha from our Investments team walks you through each step of this tool in this loom.

3.2.1 Determining Allocations

First of all, think loosely about how much capital you want to raise from different kinds of investors. Let’s say you’re looking to raise $500-600k. So, anyone putting in > $300k would effectively become the lead investor. You might want to reserve $50-70k (~10-15% of total round size) for angels (who could be strategically relevant) and the remaining amount can be filled up by other investors (syndicates, micro VCs). Broadly, this is what it can look like:

Lead Investor: Your lead investor should be doing at least 50% of the round. If not, they’re not the lead; consider them a co-investor.
Angels: Always reserve space for angels. It’s incredibly important to bring in people who have been there and done that to guide you through the startup journey.
Other Investors: The allocation for other co-investors is the balancing figure. Money is money but try to be as selective about who you want to bring on and what value they add.

3.2.2 Building Commitments

As soon as you’ve signed a termsheet with a lead investor, reach out to all the co-investors and angels who had expressed interest and confirm their investment interest and desired allocation.

🚨 Now, there is one important thing here: be very protective against dilution. 🚨

In case the commitments exceed the amount you’re looking to raise, it’s always tempting to get in a little bit more money and it’s quite difficult to say no, especially to angels.

From the termsheet, you can estimate dilution based on eventual round size. Let’s say the termsheet said the lead investor will invest $300k at $3.5mn post-money valuation. Once you’ve agreed on the valuation, you can start finalising the total amount.

If you think you need a minimum of $400k for the next 18 months, that means a little less than 11.5% dilution. If you go up to $500k, that’s a little over 14% dilution and provides you enough buffer. But if the total hard commitments come to $560k, that’s close to 16% dilution.

Here, ask yourself if the extra $60k is worth the extra 2% dilution. In most cases, the answer will be no. Please bear in mind that 16% dilution doesn’t mean the founders will hold 84%. The investors will ask for an ESOP pool to be created so with a 15% ESOP pool, founder holding quickly crashes down to 69%.

🥧 Until Series A, we recommend that investor shareholding be restricted to 30-35%. 🥧

Also, this is just the first round. You’re likely going to raise multiple rounds & with each round, every existing shareholder gets diluted.

3.2.3 Preparing the Pre-Investment Cap Table

The first cap table consists of only the founders. Here we assume there are 3 founders.

Here is a step-by-step walkthrough of this example.

It’s acceptable for founders to have unequal shareholding based on responsibilities and contribution.

3.2.4 Creating the ESOP Pool

The lead investor will invariably ask you to create an ESOP pool i.e. to set aside equity to give to early employees. The investors will tell you that the creation of an ESOP pool should not dilute their shareholding.

👩🏽‍💻 Incase your investor and you have differing opinions on the size of the ESOP pool, a good way to negotiate is to detail out the key hires you wish to make over the next 18 months and the equity that you will be roughly allocating to each hire. 👨🏽‍💻

So, the next step is for the company to keep aside additional shares for the ESOP pool (before we even consider the shares that will be issued to the investors).

Usually, the termsheet mentions the ESOP pool % on a “fully diluted” basis.

🥧 Fully diluted basis means the % in the cap table which includes all the investors from the round. 🥧

If we have to create a 15% ESOP pool on a fully diluted basis, this means that we have to start at a higher number (18.2% in this case) because the issuance of new shares to investors will dilute the existing shareholders on the cap table, bringing ESOP down to 15%.

3.2.5 Calculating Investment Share Allocation

Now, we take a look at the round construct i.e. the different investors and how much they’re investing.

For the sake of simplicity, I’ve taken 1 lead investor, 1 syndicate as a co-investor and clubbed angels into one category. Now, we calculate how many shares to issue to each of them:

The Lead investor usually makes an offer of ‘x’ amount at ‘y’ valuation. This valuation could be pre-money valuation or post-money valuation. What’s the difference between the two? Well, it’s a simple relationship:

💰 Pre-money valuation + investment amount = Post-money valuation

We have their investment amount but we need the share price, which we derive from the pre-money valuation.

Thus, at this point it is important to understand why the pre-money valuation is used to calculate share price. Let's break this down step-by-step with an example:

The lead investor proposes to invest INR 2.5 crores at a post-money valuation of INR 25 crores.
With other investors, the total round size is INR 4.5 crores at a post-money valuation of INR 25 crores.
This means the investors hold INR 4.5 of a INR 25 company = 18% of the company ( based on the value of their shares).
Now, the shareholding percentage is determined by the number of shares so we need to calculate the number of shares for the investors.
If the investors own 18% which is worth INR 4.5 crores, the remaining 82% is worth INR 20.5 crores.
We know how many shares represent 82% – this is the cap table we had after the creation of the ESOP pool so 12,230 shares.
Now, the investors can be issued shares at this price such that they get enough shares for their intended 18% shareholding.

Once we understand it, we can calculate the number of shares to be issued to each investor and the final subscription amounts. Note that fractional shares cannot be issued so you need to round this calculation.

3.2.6 Calculating Investment Share Allocation

With the number of shares, you calculate the exact subscription amount for each investor. You’ll notice that it’s slightly different from the commitment amount. Now, you have everything you need to make your post-investment cap table with founder, ESOP pool and investor holdings:

There you have it – your final cap table. Notice how each of the three founders have been diluted down significantly. This demonstrates the importance of being careful about dilution in early rounds.

The pre-investment cap table (after ESOP pool creation) and the post-investment cap table (the final one) need to go into the transaction documents. You can learn all about transaction documents in the previous playbook in this series.

3.2.7 Maintaining Investor Information

Please note that the cap table needs to contain the legal entity name of each investor. Additionally, there’s a schedule that contains the contact information of each investor – their address, phone number, email ID, and PAN card, if applicable.

3.3 To SPV or not to SPV

You often hear investors suggest founders to have a “clean” cap table. That means a number of things but, most importantly, it means the founders having ownership that’s reflective of how many rounds they’ve raised, and having as few shareholders as possible. Founder ownership makes sense because any incoming investor would like to see the founder have sufficient interest in the company, based on the stage it’s at.

But why do people suggest having fewer shareholders?

For every round, each shareholder must sign the Shareholders Agreement prepared after each round. Further, many additional documents require consent (signature) of shareholders. You need to be in regular touch with your lead investor and even the co-investors to coordinate on signing as needed. But angels work on their own (a lot of them are founders so they have their own business to focus on) – they’re more interested in the business than the formalities. Also, as a founder, do you want to follow up with 10 angels to sign individually or just have a single entity where you can easily coordinate signing?

This is where Special Purpose Vehicles (SPVs) or Roll Up Vehicles (RUVs) come into play. Basically, all the angels can invest into an SPV or an RUV which then invests into the company. In turn, that SPV or RUV is a shareholder in the company. There are companies (like AngelList & Let’s Venture) that help manage this process and maintain these vehicles in exchange for a small fee. For a founder, it’s always preferable to get all the smaller investors in the SPV or RUV wherever possible.

Of course, larger investors want to come directly on the cap table as it gives them more control but angels are usually quite happy to come into an RUV.

And that’s it!

We hope you found this Playbook on building your cap table helpful! A special thank you to Gautam Shewakramani and Mayank Gupta who helped us by adding a founder’s perspective to this module. We’d love to hear you feedback on this Playbook series as well as any other topics that you wish to learn more about as a founder. Please write to us at sharvi@goodcapital.vc.