Building a strong and supportive cap table – Part 2

In part 1 of this blog post, I discussed how to build a strong and supportive cap table in the early stages of a start-up – if you have the luxury of picking your investors. In part 2, I’ll look at what type of investors are important as your start-up grows into a more mature company. We’ll then look at managing your cap table and identify some other points to note.

Scaleup Stage – going for growth (Series B onwards)

Hopefully there will come a point where your company is seeing signs of strong product-market fit, a GTM model that is repeatable and efficient at scale, and revenue that is growing quickly. That base of recurring revenue can fund ongoing activities if needed. But you will have opportunities to expand into new products, markets or verticals that will require additional capital.

The principles of the previous phases of growth are still true when selecting investors at this stage. However, the company needs to ensure there are deep pockets on the cap table. These expansion initiatives always cost more than budgeted, particularly if they involve a heavy investment in growing internationally. The company may need partners to fund multiple $10m, $20m or even $100m+ rounds.

As this will likely be new territory, you should look for investors that have expertise scaling into new markets and that can help your team avoid some of the pitfalls of expansion. The ability to help you prepare for an eventual exit event is also important. These investors could be founders or operators that have taken Australian businesses global, or VC/institutional investors in the US (or your target market) that can leverage local knowledge and networks to provide support in addition to capital. If you’ve managed to attract VC funding locally, those funds should be able to help you partner with these overseas investors.

Growth equity/PE investors become more active at this stage. They can write large cheques and provide sizeable operational support teams and sophisticated governance. Be aware though that these investors have a different growth mandate, ownership and control expectations and work with businesses differently to VCs.

At this stage, founders and employees will likely have been putting everything into the business over several years and will have their wealth tied up in the company’s equity. This is a good time to bring on a liquidity partner that can take financial pressure off the team and allow them to double down on the business with more intensity. While traditional VCs can allocate a portion of a round to secondary purchases to realise this value, a specialist secondaries fund like SecondQuarter Ventures (shameless plug here!) can provide a regular flow of smaller cheques after a round. This sort of partner is an effective retention tool for employees. We were fortunate at Aconex that our base of HNW investors were happy to facilitate these secondary sales and this helped create the genesis for SecondQuarter.

Managing your investors and competing interests

Both during and after your round, make sure you communicate regularly and transparently with investors.

During the round you should set expectations on valuation, terms and timing. Investors will have similar processes but will differ in the level of due diligence they conduct, cheque sizes and time they take to make a decision. Clear communication helps make sure everyone is on the same page.

Once investors are on the cap table you should communicate with them as a group at regular intervals. At Aconex we sent investor summaries monthly, with more detailed updates each quarter. We were careful to tell the whole story, warts and all. Investors don’t just want to hear the good stuff; they want to know where you are struggling, what you are doing about it and how they can help. This gives them confidence and speeds up their decision at the next fundraising round.

You should also be pro-active with your investors individually. Most have a large portfolio and may engage with founders only on an ad hoc basis. Get your share of attention by organising regular standing catchups. If you want help in a particular area from an investor, ensure there is structure to the engagement so that you get the most out of it.

It is clear that funding rounds are getting more competitive. There has been a sharp increase in the number of investors in Australia, and in interest from abroad and from later stage investors (although less so in the current market). If you are fortunate to have an oversubscribed round, any good potential investor will want the company to have the most valuable cap table possible.

If this means scaling back allocations to fit in people or organisations that can help the company, incoming investors should be very happy to facilitate this. Beware of investors looking to take the whole round or not offering any flexibility. It is unlikely one investor will be able to offer everything you need from your cap table or can be better than the collective group.

Start-ups are still a team sport and it’s worth repeating – if someone can be helpful, find room for them on the cap table!

Other things to consider:

• Advisors: Taking investment from professional advisors like lawyers, accountants, consultants or bankers can add value to a cap table. At Aconex, we had advisors like Adam Lewis (McKinsey) and Michael Robinson (Allens) that could help guide the company strategically, ensure good governance and resolve difficult issues and competing interests which are bound to come up.
• Corporate VCs: A lot of large corporates now have venture arms. Their activity will often be closely aligned with corporate strategy and they may move more slowly than traditional VCs. There are great investors in this field in Australia, but make sure they fit the overall direction of your company.
• Customer investors: Having a customer as an investor can send mixed signals depending on the business. For a lot of companies, like Aconex, it is important to be seen as independent from any industry stakeholder, so having a customer on the cap table is not practical. You can sometimes get around this by having individuals associated with customers invest in their own right. In other instances, like in D2C or SMB, having customers on board can strengthen buy-in from the market and help build community.
• Number of investors: If you are going to be raising multiple rounds, try not to add too many names to the cap table at each stage. In Australia, once you exceed 50 shareholders the company will need to become a public unlisted company, which comes with more onerous admin and transparency on reporting. There are structuring solutions to this issue – like using nominee entities – but the longer you can delay the better. Remember though, this trade-off may be worth it to bring in investors that can increase the value of the business.
• Treat existing shareholders well: Your early investors took the biggest risk. Assuming they’ve been supportive and believe in the company, you should treat these investors well at future rounds and give them an opportunity to reinvest, irrespective of pro-rata rights (or views of new investors).