Founders often query how large their cap table should be.
How many investors is too many? And what factors will influence this?
Below we chat about some important things to consider when your cap table is growing. We also provide some strategies to help keep it tidy and agile, or to clean it up later on.
The below is just a high level summary of what can be quite a complex topic, unique to each company’s goals and circumstances. All companies work differently, and this will flow right through to the way they manage their cap table too.
If you have any queries at all, please get in touch!
A growing cap table
The number of shareholders on your cap table will increase because:
- you’re raising capital, and new investors become shareholders, or
- you’re offering ownership to employees, and those employees are becoming shareholders.
The speed at which the cap table will grow can really depend on how you’ve approached the above. For example, if you’ve raised capital from lots of individual family and friends, or lots of small-scale angel investors, you may quickly gain 30+ shareholders. Alternatively, if you’ve only taken investment from large investors who can take up your entire round, your cap table will be kept small.
Likewise, if you’ve set up an ESS instead of an ESOP for 10+ employees, this will speed up the growth. Alternatively, if you’ve set up an ESOP instead, and clearly communicated to the employees that they have the ability to hold off on ‘exercising’ their options until an Exit Event, your cap table can remain more nimble.
What are the rules?
In Australia, a private company can have a maximum of 50 (non-employee and non-CSF) shareholders.
If it goes over 50, it must convert to a public (unlisted) company. Public companies are subject to more stringent rules and compliance regulations (including the Takeover Provisions, discussed below). This can often be a burden for a start-up focused on growth. Compliance costs will also increase, and directors and founders can lose various aspects of ‘control’.
While ’employee shareholders’ don’t count towards the 50 shareholder limit for converting to a public company, they do count towards the limit in relation to the ‘Takeover Provisions’ applying. In short, the Takeover Provisions regulate the way a company can be bought or sold. This means that an acquirer generally has to make a formal ‘takeover offer’ for a sale to occur.
A takeover under the Takeover Provisions can often take months to complete, and can be significantly more expensive than a ‘quick deal’ that start-ups are often looking for. Sometimes, the fact that a formal takeover offer is required can actually discourage a potential buyer from starting M&A discussions with a company altogether, due to the sustained effort and costs involved. If the buyer isn’t discouraged by the Takeover Provisions completely, they may still use the complexity as leverage in their negotiating position.
The buyer will almost always deduct the legal costs of the deal from the purchase price – this can sting.
Other implications of a big cap table
Aside from the laws and rules above, there are more practical implications to consider if your cap table is growing.
Resolutions and documents being signed: Under most Shareholder Agreements (and constitutions), there are a number of matters that require shareholder approval. Most start-ups will get approval by way of a ‘circulating resolution’, rather than holding a shareholders meeting. This requires the shareholders to all sign a document confirming their vote.
If a start-up has 30+ shareholders, this can be a tedious process. This can be especially frustrating where you need a quick approval.
Keep in mind that for each shareholder, you may require multiple signers (ie, two directors of the investment entity).
Cake is able to streamline this process by allowing you to send members resolutions through the platform, and to track and follow up those signers. This will also avoid you needing to compile multiple copies of one signed resolution.
We often see customers with 40+ shareholders have their members resolutions signed within days, instead of weeks.
Cooks in the kitchen: Depending on who your investors are, they may want to have an active input into the business. While this input is often appreciated, it can become tricky where there are too many parties (cooks) involved. For example, if you have 30 small shareholders all wanting a say in how the company should be run, it can get distracting.
Investor attraction: Venture Capital and larger angel investors often prefer ‘clean and concise’ cap tables. This is because they know the company can be more agile, and that it won’t risk being restricted by a large number of small shareholders where it matters.
While a big cap table won’t necessarily be a ‘deal breaker’, it’s still worth keeping this point in mind during your early days.
Below are a few strategies you can implement to keep control of your cap table size.
Minimum raise amounts
When starting a raise round, you can set minimum investment amounts per investor. For example, you could say an investor must invest at least $50k. This way, you’ll just have the 1 shareholder on your cap table for that investment, rather than 10 investors at $5k each.
Some groups of small angel investors may be able to invest as one entity through their own investment vehicle. Sometimes, an angel may also be able to join a pre-existing investment vehicle to get involved in the round.
Communicate clearly with your option holders, so that they understand how they may be able to hold off exercising their vested options.
On Cake, we generally only see options exercised when:
- an Exit Event is likely, or
- the employee is leaving and is required to exercise before that.
Otherwise, the employees often leave the options as vested but unexercised options.
Decide on your company strategy before starting your round. For example:
- decide how many investors you’d ideally like to have on your cap table in the long term. Not all companies can request a $50k minimum, so perhaps put a cap on the number of small investors in the seed round, with the aim to implement the minimum investment amount in later rounds.
- consider what role you want those investors to play. For example, will they be passive or active investors?
- keep in mind that your Convertible and SAFE Notes will convert to shareholders too.
What if my cap table is already tricky?
It’s pretty normal for a start-up to grow their cap table way quicker than they expected. And when this happens, they often won’t feel the pain of having a ‘big cap table’ until it’s too late.
Below are a few suggestions if you are looking to reduce that pain.
It’s possible some of your investors are willing to sell their shares back to the company, for a return on their investment. Keep in mind this will require the approval of the other shareholders, and of course the company will need the cash on hand to facilitate it.
Bare Trusts are a funny creature, worthy of their own blog (stay tuned).
However, as a summary, a Bare Trust can allow a number of investors to be counted as one single shareholder on a cap table.
This is done by having the legal ownership of shares for a number of investors transferred to a Trustee, who holds those shares on trust for the individual investors. Not only does this avoid the 50 shareholder limit, but it can make it much easier to get things done quickly. For example, the trustee could sign resolutions on behalf of all beneficial holders.
This agility can be very attractive to companies that have been getting bogged in admin.
We would highly recommend seeking legal advice before going down this route, as there are a number of things to consider. Our legal partners can chat with you and help to set up this up if it’s suitable. The Bare Trust structure can be facilitated on Cake.
Agile Shareholder Agreements
Your lawyer could amend your Shareholders Agreement so that
- shareholder approval is only needed where absolutely necessary, and
- minority votes can be aggregated into a single vote.
This can again reduce the pain point in chasing signatures during a transaction, where timing is critical. If you’d like to chat to a start-up lawyer about this, let us know.
Every company is different
For some companies, a large cap table may not be a problem.
For example, if a company was expecting to list in the near future, having more shareholders while private may not be a problem. Similarly, if a company was in frequent contact with its shareholders and had an agile Shareholders Agreement, it may not feel the pain.
The key is often to focus on your company goals and objectives first, and then your cap table process and strategy can follow.
This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.