The lowly cap table, or capitalization table, is probably document number 15 or 16 on the request list of buyers. Entrepreneurs send it off thinking that it probably transmits nothing more than who owns what shares in their business. In some cases yes - but other times your cap table can tell a story about your history, your thoughts on employees, and your company culture.
Here Are Four Things A Buyer Can Learn By Looking At Your Cap Table
1) How Much Equity Does the Company's Leader Own?
This might seem like an easy one, but it is not always the case that the person at the top of the org. chart owns the equity - and that can cause some problems. If the person who has been creating value in the position of CEO or President doesn't have any ownership, a potential buyer - especially a financial buyer - may look for a way to incentivize that person to stick around to continue to create value. An example of this situation is an absentee owner who has hired a very competent CEO who runs a great organization and has created a tremendous amount of value in the company. For that CEO, a sale is going to be a giant freak out moment - they don't own any equity - they are going to fear for their job, they are going to have to play nicely during a sale process, and due diligence is going to be a distraction. This is not the best way to go into a sale process and for a buyer, this is going to be a key employee that may or may not be happy to come along.
1a) Equity and Key Employees
If you are a company that has key employees - especially in the technology sector - you may want to think about equity or options for this group as well. Buyers will see that the team has an incentive to maximize value and has had a history of being aligned with ownership. Financial buyers will often want to replicate this set up with a continued investment going forward.
1b) Equity and Former Employees
Alternatively, if you have had key people leave the business that have held stock, this will show up in the cap table. Be prepared to answer questions about the role of the employees who left. Why did they leave and for what areas were they responsible? Are there any potential lawsuits?
2) How Many Investors Do You Have?
A sales process involving one owner on a cap table is relatively easy. A handful of owners can be more challenging depending whether or not one person has the vast majority of the stock or they each own an equal amount. It is much easier to deal with one party than it is to deal with three, for instance. In the case where there are many shareholders, a buyer may ask that the owners elect one spokesperson that negotiates for the group in order to alleviate that issue. A company that has many small investors - such as a company that has gone through several series of financing rounds or has many generations of family members involved - can be seen as trickier to acquire than a business with one or two shareholders.
3) Who Are Your Investors?
If you have a bunch of small shareholders who all believe that they have a say in the business, that can be a huge challenge to a successful sale (and running a business in general), but if you have investors that double as advisors, that can be seen as a positive. Unreputable investors can damage your business value before you even begin your sale process and investors that have historically made quality choices will carry value with them.
4) Is It Full Of Weird Structures?
Many entrepreneurs fall prey to this as they are growing and raising capital - as they raise money, they promise different investors different terms. These can be liquidation preferences, promised return thresholds percentages, etc. A cap table that is full of different structures introduces a lot of complications to a transaction and greatly increases the likelihood that a particular investor will be unhappy with the outcome of a transaction.
As an entrepreneur bootstraps a company together, the last thing he or she thinks about is a buyer scrutinizing their cap table upon the eventual exit. As a business owner, your cap table is your cap table. My advice would be to try to keep it simple, keep it clean, and know what's on it. If there are abnormalities, there will be questions and you should have answers ready. While it may seem tedious to update your cap table and keep track of equity, especially if you have a complicated structure, you will find it is well worth it during the sale process when the inevitable question, "Can I see you cap table?" comes up.
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