Startup founders’ ownership levels on the VC track

How to avoid cap table problems

I am an Associate at Icebreaker. We are a pre-seed fund which means that we make lots of investments and look at lots of companies. We want to invest as early as possible and we are often the first investors to take the leap of faith. We’ve made 90+ investments so far in bridging the pre-seed gap in Sweden, Finland, and Estonia (get to know some of our portfolio cos here).

My main responsibility is to do the first screening of companies, and if interesting, carry them forward to the Partners.

There are a thousand reasons as to why we might pass on a company given that we, as much as possible, stay true to our thesis centering around 3 pillars: Domain Expertise, Strong Tech, and Global Opportunities.

You should see the look on my face when a couple of strong entrepreneurs pitch me and end up ticking all the boxes — wow! However, we still have a long way to go before an Icebreaker term sheet is lobbed over. I need to know what the cap table looks like given that we only invest in pre-seed companies.

At Icebreaker, we have what we call “hygiene questions.” One of those questions goes as follows: “How much equity do the active founders and employees own of the company.” A simple question to which I often dread the answer.

The Problem

I’ve heard answers to that question ranging from 5% — to 100%.

“My friend pitched in 50k for me to get started, and I gave him 50% given that the company was only an idea at that point”

- Founder that couldn’t raise venture capital

This sounds reasonable, but I am afraid it is not viable for the VC Track. If you own less than 80% when you are at a pre-seed stage level and have yet to take a major outside investment, it will be a great challenge for you and your team to progress along the “VC track.” However, I want to make it clear: not all companies have to take the VC Track; there are many other ways! Just look at Zapier — they only raised €1.4m back in 2012 and reached a €5Bn valuation in 2021 with €140m in ARR. Well done! However, most companies are not so fortunate and actually need VC funding to win. Most of the largest tech companies could never have gotten to where they are today without lots and lots of funding. In the U.S., between 20–30% of IPOs come from VC backed companies. Should your company be the type of company that needs funding to get the machine up and running, and even more funding to grow at a rapid pace to outrun competitors, this is what you need to know:

Investors at the different stages of funding (pre-seed, seed, Series A, Series B, etc.) expect certain ownership by the active members of the team. Why? Well, just imagine the extreme scenario and it should be clear why. If active founders and employees owned a total of 1% and the passive funding angel owned 99%, why would the active members of the team want to put in the work? They would have little incentive to put in the crushing effort often required to increase shareholder value. Now, giving away 20% to friends and family who put in €50k when all you have is an idea may seem reasonable. Unfortunately, this is where many are mistaken if they are planning to step on the VC train.

Pre-seed investors will typically expect at least 90% owned by active founders and employees. Why? Because → Seed investors will typically expect 70% owned by active founders and employees. Why? Because → Series A investors will typically expect 50% owned by active founders and employees. Why? You get the drill.

Keep in mind that these numbers are rough estimates. A study of U.S. startups found the following evolution of ownership in employees and founders at the various stages:

These ownership percentages should be adjusted slightly downwards to get to reality since:

• The study does not take active/passive into account, and;
• this is the average, not the median. Like Zapier, the outliers end up skewing the numbers upwards, and my guess is that there are very few companies that skew things downwards (too low ownership) since investors will rarely fund those companies.

The Beginning of a Solution

If you have a cap table that is not healthy and you want to take the VC track, you need to increase the ownership of the active founders and employees, which can be done by:

• issuing option pools,
• allowing new investors to buy shares from passive shareholders, or
• founders buying back shares from earlier investors

Option pools dilute all shareholders, investors buying shares of passive shareholders is always tricky, and buying back shares as a founder can be expensive if shareholders are unwilling. There is no one-size-fits-all solution, and the specifics of navigating how to revive your cap table are beyond the scope of this article.

Nevertheless, I hope you now understand the investors’ perspective concerning cap tables and why they matter so much. And if you are an early-stage founder looking for funding — let’s talk!