The CEO of a Norwegian hardware startup shared a pitch deck with me that had an unusual slide. It included the company’s capitalization table — the breakdown of who owns what part of the company, typically shared in the diligence phase of investing.
Taking a closer look at the table, something significantly amiss:
This cap table is a reproduced, accurate illustration of the cap table that was in the deck. It’s been simplified and redacted to remove the names of the investors. Image Credits: Haje Kamps/TechCrunch
The company has given up more than two-thirds of its equity to raise $3.3 million, posing a serious hurdle as it starts a $5 million fundraising round.
TechCrunch spoke to several Silicon Valley investors, finding that the current cap table essentially makes the company uninvestable, but there is still hope.
Why is this such a big problem?
In less sophisticated startup ecosystems, investors may try to acquire a significant portion of a company’s equity in small funding rounds, leading to long-term consequences that limit the company’s growth potential.
Leslie Feinzaig, general partner at Graham & Walker, pointed out the red flag in the current cap table and emphasized the importance of aligning incentives between investors and founders from the start.
Feinzaig suggested that fixing the cap table by returning ownership to the founders could be an aggressive move but necessary for making the company investable.
With unmotivated founders, the risk of an early exit increases, leading to mediocre outcomes and limiting angel investing opportunities within the startup ecosystem.
There is a potential solution
Hunter Walk, general partner at Homebrew, emphasized the importance of keeping seed and Series A cap tables looking ‘normal’ with founders retaining healthy ownership.
The hardware company CEO explained how the company ended up in this situation due to a lack of startup experience, accepting unfavorable terms initially, and facing challenges during product development.
The company plans to raise the current round and then correct its cap table, but international investors may have concerns about the existing dynamics.
Cleaning up a cap table
Mary Grove from Bread & Butter Ventures highlighted the importance of founders owning a significant percentage of the company at the seed stage and suggested corrective measures to realign ownership structures.
Ultimately, the risk profile of the company depends on its specific circumstances and future capital needs.
Rewinding the choices
The CEO reflected on past decisions that led to the current cap table issues, highlighting the challenges faced in startup ecosystems like Norway due to limited access to good advice and differing norms.
While there may be opportunities for non-local investors to offer more favorable terms to early-stage startups, the potential drain from the local ecosystem poses risks to its development.
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