Understand your CAP table (our two fils)
Hey folks,
We’re back with this month’s newsletter and have some fresh scoop. We’ve been talking to a variety of interesting startups this month while continuing with our fundraising discussions for Arzan VC II.
Earlier this month we were invited to participate in Mix N’ Mentor in Kuwait and it was awesome to meet so many talented entrepreneurs. Although there were primarily non-tech startups, we are starting to see an emergence of some in Kuwait.
Anurag with the energetic group he joined
With multiple tabs open and endless distractions, if you don’t make it to the end of the letter, we’d like to wish you a happy Ramadan from the Arzan VC family 🌙
MENA Delivery Startups
The food delivery space is massive in MENA. There’s a lot of overlap ranging from food portals to one-store delivery services. We’ve focused on multi-vendor delivery companies.
Who do you think should be on here?
How can they differentiate?
Join the discussion at #arzanVCchats
Understanding your cap tables: our two fils
| We see tons of startups at ArzanVC, and we tend to see common pitfalls amongst them. One of those is in the CAP tables of startups. Since AVC Venture Partner Anurag works closely with these startups on legal documents before we do invest, I asked him to share his experience and this is what he had to say… |
- Founders give up too much equity to early stage investors
- Founders’ shares do not vest
- No or limited employee stock option plan for key members
Let’s take a closer look…
1. Founders give up too much equity to early stage investors
In all the shareholding structures that we saw, the founder already owned too little equity at an early seed stage. Having this structure as it currently exists is a complete non-starter. While you don’t necessarily need to have 100% of the equity, you as a founder need to have at least 75-90% as you head into the first round of institutional funding. For example, here’s an illustration of what the CAP table looked like for one company we evaluated in Jan’17:
In the above instance (Actual CAP Table), the founder owns almost nothing at the time of exit due to the dilution in multiple rounds. Think about it: what would motivate the founder(s) to continue working for this startup? How would future investors look at such a situation? What impact would it have on future funding rounds?
On the other hand, in the revised cap table, the founders along with the key employees (through ESOP) own 70% of the company after the angel round of funding. Starting with this ownership structure guarantees that the founders along with those key employees own a substantial minority at the time of exit, motivating them towards that goal.
Why do we see a lot of the first kind of cap table? First, a lot of founders are desperate to raise money from any investors. Second, investors -mostly angels- are partly to blame for this as they demand high equity percentages (“I need 40% for $100k”) in a company rather than giving money to founders at fair valuations (“I would invest $100k for a post money valuation of $500k”).
To remedy this issue, founders need to always raise money based on fair valuations, keeping in mind the dilution effect. If an investor asks for a high equity stake, DON’T TAKE THE MONEY.
2. No vesting of founder’s shares
Any startup that wants to build a successful enterprise should vest its equity over time, particularly for founders and key employees. A carefully thought out and deliberate vesting schedule can prevent difficult conversations with investors or, worse, lost equity in the hands of departing team members.
Very few companies we evaluated had founders’ shares vesting. It is a very important aspect for a startup as it addresses 3 main issues – 1) keeping the founders enthusiastic and motivated, 2) whenever a founder decides to leave, you can fill his position with a new founder and give him the unvested stake of the leaving founder and 3) investors and other stakeholders see it as a sign of commitment; the founders want to get their due share only after achieving something.
Note: The legal aspect of vesting varies significantly from country to country. Consulting a lawyer is generally a good idea.
3. No employee stock option plan (ESOP) for key members
Stock option plans are as important as vesting because in every startup, a founder will have to hire key, high caliber team members. At an early stage company, founders seldom can match or pay more than industry standard salary to these members. Realistically, the only way a startup can keep these key employees motivated is through stock options (also vested over time).
Ideally, a startup should have a minimum of a 10% stock option plan (going up to 30% in some cases) in their CAP table before the first round of funding and the ESOPs can be distributed over any period of time.
Lastly, we believe the progression in case of most startups would be something like this. The infographic is a general example and in no way represents 100% of the actual scenario a startup would go through. It gives you a good idea on how a founder should distribute equity in his company over the period of time.
| (too long; didn’t read)
Managing your cap table and equity options is not easy, but it is not something impossible with the right research and planning. Seek advice from investors, lawyers, and other founders. A clean Cap Table and solid stock option plan can be worth more than a million-dollar investment alone. What challenges have you encountered while constructing your Cap Table?Tweet us at @arzanvc |
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Smart founders learn what didn’t work for others (also here & here)
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An excellent piece on the rare hockey-stick growth model
Family Postcard
Storage just got even better
In addition to its tech-enhanced blue boxes, Boxit now also stores customers’ own boxes, suitcases and large items like fridges, TVs, beds & sofas. Time to declutter!
They be killin’ it
Tamatem released its new car drifting game and hit number 1 on the Saudi app store in less than 24 hours. Yaaaaas.
Only on your phones guys, please
Happy Ramadan!
Keep it real,
Hasan Zainal
