The fact that you are reading this means that you are an entrepreneur, business owner, or planning to become one. You are our heroes and we applaud you for taking on this journey and challenge. One of the most important things that you can do in starting a business is properly being able to control your cap table. And controlling your cap table will enable you to have a business that can grow and scale.
What is a Cap Table
So first off, a cap table is the list of owners of equity in your business and how much equity you have reserved to sell or grant in the future to additional owners, including employees or investors. Here’s a visual example of what a cap table looks like:
How to Control Your Cap Table
What does it mean to “control” your cap table? With an Operating or Shareholder Agreement, there are two different philosophies that are in tension in each. On one hand, you can err on the side of protecting the company, and on the other, you can err on the side of protecting the owners.
I often see owners make the mistake of erring on the side of protecting the owners in a way that lays roadblocks in front of the business when it tries to grow and scale. Anti-dilution clauses and requiring unanimous consent from owners to authorize and issue new equity are the most common ways people stumble when trying to grow a business. In my professional opinion, I would trade an anti-dilution provision for preemptive rights, and unanimous approval for supermajority consent and good faith requirements.
What to Include in Your Operating Agreement or Shareholder Agreement
Now that you have a business that you want to scale, and you want the company to control the cap table instead of having an owner-controlled cap table, what’s next? Here are 5 items that you should consider when preparing your Operating or Shareholder Agreement:
Pick the right equity splits and use vesting even for founders
Include Buy-Sell provisions
Rights of First Refusal
For-Cause Repurchase Rights
Provisions to Avoid in Your Operating Agreement or Shareholder Agreement
Not only are there some provisions you should include in the Operating Agreement of Shareholder Agreement, but there are some you should avoid. Here are 2 provisions (that we briefly mentioned previously) you should keep out and not allow in your Operating Agreement or Shareholder Agreement:
What to Include
Equity Splits and Vesting
With the right provisions in your Operating Agreement or Shareholders Agreement, you need to consider how to split and allocate the company’s equity. When determining how much equity to give co-founders, employees, or other owners, you should take into consideration a number of factors:
The potential value of the idea and concept of the business;