How to Structure Your Cap Table Without Sabotaging Future Rounds?

There are 4 cap table red flags that can derail a funding round: undervaluation in the previous funding round, an exited founder with outsized equity, existing investors holding significant influence over operations, and ill-managed employee stock options.

If a startup was undervalued in the previous round, the accurate present valuation appears inflated.

When an exited founder has too much equity, it simply means that they are being compensated for the efforts of others. Incoming investors may even see this as having to take on risk to build an unrelated party’s fortune.

The investment objectives of existing investors might clash with those of prospective investors. So, if existing investors hold too much influence, they may block the entry of prospective investors.

Finally, ill-managed employee stock options can result in excessive dilution or inability to attract and retain talent.

With this article, you will learn how to evade these four cap table red flags and improve the chances of fundraising success.

Four Strategic Steps to Prepare Cap Tables for Future Funding Rounds

The following strategies will guide you in maintaining a cap table conducive to attracting investors and retaining control, right from inception.

1. Use SAFE notes to delay valuation negotiations

In a funding round negotiation, as a founder, one of your primary considerations would be avoiding undervaluation since it results in unnecessary dilution. Furthermore, when a startup secures funds at a low valuation, it may struggle to secure a favorable valuation in the future. This is because the low prior valuation can make any subsequent valuation appear inflated.

On the other hand, investors can be overly cautious about investing at high valuations, especially with early-stage startups.

So, not only is it difficult to establish the valuation of an early-stage startup, but the downsides of inaccurate valuations for investors as well as founders are significant. Thus, it is in the best interest of all parties to avoid setting a valuation in early-stage funding rounds.

In such situations, startups should raise funds using Simple Agreements for Future Equity (SAFE) notes. Here, instead of offering equity at a specific valuation, you offer the right to receive equity at a discounted stock price or valuation cap.

Suppose you raise $1 million from an angel investor using a SAFE note with a valuation cap of $10 million or a 20% discount on the future share price, whichever fetches more shares.

This would reflect in your cap table in the following manner:

Now, suppose that you raised $5 million by issuing 200,000 shares in the next funding round. This results in a share price of $25.

Then, the angel investor’s post-conversion shareholding can be calculated as follows:

Note: Pre-money capitalization is nothing but the total number of shares (including options) before the funding round.

In this example, the valuation cap conversion will be used since it fetches more shares. Post-conversion, your cap table will take the following form:

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2. Periodic vesting of founder equity

A common cap table mistake founders make right at inception is simply dividing the equity equally among all founders. There is no inherent problem in dividing the voting power equally among founders. However, if stocks are simply distributed at inception, a founder could walk away with significant equity before making contributions worthy of the equity.

Hence, it is important to apply a vesting schedule for founder equity. For instance, you could adopt a founder equity vesting schedule of four years.

But, unlike employee stock options, you must not adopt a vesting schedule where common stock conversion occurs at the end of a year. Otherwise, if the startup onboards any investors in the first year of operation, the entire voting power would end up with external investors until the founder equity vests for the first time.

So, you could issue founder equity in the following manner:

1. A certain number of shares must be equally distributed among founders upon inception
2. The same number of shares should vest every year for a specified number of years

This kind of structured vesting is a form of indirect compensation, which can be a powerful tool for retaining key talent over the long term. These methods like stock options and profit-sharing help align individual incentives with company performance.

Such a founder equity plan would shape your initial cap table in the following manner:

In this example, 250,000 shares are distributed equally among four founders at inception. Then, every year for the next three years, a combined 250,000 shares will vest for the founders.

3. Raising funds through non-voting equity interests

Retaining control of one’s startup is a key concern for most founders. The best way to achieve this goal would be to issue non-voting equity interests. An example of this would be preferred stocks. Such equity interests guarantee a certain income level but do not carry any voting rights.

Due to the difference in income and voting rights, preferred stocks typically have a different share price than common stocks.

Let us continue our example to see how preferred shares would be represented in a cap table. We will assume that your startup raised $1.2 million using preferred stocks that carry a share price of $6.

Certain investors may fear that selling preferred stock would be more challenging than selling common stock. In such cases, you might need to issue convertible preferred stock. When you issue convertible preferred stock, you must carefully choose the conversion ratio. An overly generous conversion ratio would defeat the original purpose of protecting your voting power.

When you issue convertible preferred stock, you should consider increasing the size of the founder equity pool. This, too, will allow you to counter the future deterioration of voting power.

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4. Appropriate employee stock option pool

At startups, employee stock options form the cornerstone of hiring strategies. Since a startup’s equity can offer substantial returns, it is highly effective in attracting talented employees, retaining, and keeping them motivated.

However, due to the high-risk nature, employees may value stock options only after a startup has secured its first major funding round. So, you may not need to create an employee stock option pool at inception or after seed funding. But such an option pool might be necessary after Series A funding. In high-growth scenarios, reverse vesting can play a key role in protecting equity and ensuring long-term commitment from core team members.

The size of your employee option pool should depend on the following factors:

• Number of existing employees
• Number of vacancies
• Standard compensation for vacancies as well as existing roles
• Industry norm for the portion of compensation made up of stock options

Your human resource managers may prove instrumental in such research.

Continuing our example, the addition of an employee stock option pool would reflect in the following manner in your cap table.

If you have a large number of employees, you might be concerned about the impact of employee stock options on your voting power. In such cases, you should consider alternate forms of stock-based compensation such as stock appreciation rights (SARs) and phantom stocks.

The presence of an ESOP in your cap table can be an important disclosure to your investors. Assessing the size of this option pool would help investors verify that you are doing enough to attract talent without causing undue dilution.

Streamlining Equity to Structure your Cap Table Seamlessly!

The key objective of cap table management is balancing control and incentives. The founders must retain enough equity to freely follow their vision. At the same time, employees and investors must have enough incentive to take the risk of following and supporting the same vision.

While it is ideal to fulfill this core objective primarily with traditional forms of equity, at times, you may need to issue complex securities such as warrants, convertible debt, and Simple Agreements for Future Equity (SAFE).

In such scenarios, you might need to rely on a cap table management software to keep track of ownership.

Growth Hackers is a results-driven startup consulting firm helping businesses from all over the world grow. There is no fluff with Growth Hackers. While we don’t manage cap tables directly, our digital marketing expertise supports investor-ready growth by helping startups build strong brand visibility, attract the right partners, and position themselves strategically for future funding rounds. With compelling storytelling, data-driven campaigns, and targeted lead generation, we ensure your business is set up for sustainable traction and investor confidence. If you’re preparing for funding and want to align your marketing with your startup’s cap table goals, contact Growth Hackers today to discuss a tailored growth strategy. You’re just one click away from accelerating your business journey.

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