Why do some companies, such as Airbnb, Facebook, and SpaceX, remain under the control of their founders, while others transition into the hands of their investors? Take Tesla, for instance: the original founders were Martin Eberhard and Marc Tarpenning. After three years of developing a prototype from 2001 to 2004, they met Elon Musk, an early investor who now controls and serves as the CEO. How and why do these shifts in control happen? What determines who ultimately controls a company?
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Enter the Capitalization Table – or Cap Table for short. A cap table basically lists all the owners of a company and the percentage of the company each owns. To explain how a cap table works consider another well-known company: Airbnb. Its founders, Brian Chesky, Joe Gebbia, and Nathan Blecharczyk, created one of the most founder-friendly companies by ensuring they retained majority ownership of the company shares in their cap table.
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To explore how you can establish a founder-first company, we will use a Cap Table template we've created for you. This tool visualizes how a company's control changes over time through a Timeline tab. You'll also find a Dashboard in the template that shows the evolution of ownership structure between investors and founders. The template breaks down investment rounds from Pre-seed to Series C and incorporates a variety of investment tools, including SAFE notes and Convertible notes.
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By the end of this article, you'll have the tools and knowledge needed to best prepare yourself against a company takeover. Once you understand how Downturns, Post-money, Pre-money, Valuations, and all those fancy terms work – it will be much easier to build your own founder-friendly venture like Airbnb.
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As a company matures, it moves through funding stages. In the spreadsheet template we'll use in this article, each stage is in its own tab – titled in sequential order: Pre-Seed to Series C.
Let's discuss the Pre-seed round. Using Airbnb as an example, imagine the founders equally divided company ownership. Initially, they convert the conceptual value of their company into Common shares, even before a product or technology is in development.
At the Pre-seed stage, a company might not have a tangible product but can have millions of Common shares. Common shares represent primary ownership in a company. Shareholders can influence company operations, potentially earn dividends, and more. In our Airbnb example, each founder receives 1,000,000 Common shares, totaling 3,000,000 shares or 100% company ownership. By the end of this round, each founder owns approximately 33% of the company.
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Now that we wrapped the Pre-seed round, let's talk about the next stage – the Seed round. In a Seed round there is typically a prototype that has been built and something to show potential investors. At this stage, the investors are typically friends and family members and they have no clue what the price of each Common share of the company should be worth – is a Common share worth $1, $2, $3? That is, it is unclear in the early days of Airbnb if the entire company was worth $3 million, $6 million, or $9 million. What percentage of the company would an investor that invests $10,000 get? Meaning, what is the valuation of Airbnb?
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Valuation is how much you (and your investors) believe your company is worth. If your company's valuation is $100 dollars, then an investor that invests $10 dollars might expect to receive 10% of the company. However, at the Seed round it is really hard to tell what your company is worth.
This is where SAFEs and Convertible Notes come into play.
A SAFE note, or Simple Agreement for Future Equity, is a contract that allows an investor to buy shares in a company without establishing a valuation. The investor gives money to the startup knowing that said startup will raise more funding in the future when their valuation is better defined. In the future, when a professional investor does a comprehensive financial analysis and comes up with the Valuation for the company – the SAFE note investors can convert their SAFE notes into Preferred shares of the company at the same valuation – but with an extra discount or reward for being an early investor.
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For example:
Say you started Airbnb and created three million Common shares. Your uncle invested $10,000 using a SAFE note. A few years later the company raises $1,000,000 in funding from professional investors that values the company at $12,000,000.
Since your company has 3,000,000 shares, that means each share is now worth $4. And your uncle who invested $10,000 early on now gets 2,500 shares. Using simple math, the professional investors would have about 8% ownership of your company, and your uncle around 1%. However, because your uncle was an early investor, the SAFE note may grant him a Discount when purchasing his shares.
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The Discount is a way to reward your uncle for the extra risk he accepted when no one else wanted to invest in you. The SAFE note might give him a 30% discount. Meaning that your uncle can buy each share for $4 * (1 - 0.3). That is, each share would cost him $2.8 dollars as opposed to $4. Allowing him to then receive 3,571 shares instead of 2,500.
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The above example is a cartoon-level explanation of how a SAFE note works. SAFE notes were created by YCombinator, and there are lots of articles and videos explaining how SAFE notes work in case you wish to learn more about them.
A much more investor friendly (and less founder friendly) investment tool is a Convertible note. A convertible note is like a SAFE note, except that the company has to pay interest while it is creating a product. For founder friendly tech companies, convertible notes are a dying investment tool. However, we wanted to mention it here, and we've included it in our Cap Table for completeness.
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Going back to our hypothetical example of the Airbnb cap table: Brian, Joe, and Nathan are gearing up for a Seed round of funding. They've managed to attract the attention of two angel investors, one wanted a SAFE note and the other a Convertible note.
To add a SAFE note or Convertible note in the template, navigate to the tab that represents your company's investment stage. Then, scroll to the right until you find the investment instrument you wish to use.
An important detail about valuation is that investors can invest in your company based on either a Pre-money valuation or a Post-money valuation.
Pre-money valuation: is the valuation of the company just before new investments are made. If a company has a pre-money valuation of $4 million and raises $1 million, it would then have a post-money valuation of $5 million ($4 million pre-money + $1 million new investment).
Post-money valuation: is the valuation of the company immediately after the new investment. Using the above example, if a company states they are raising $1 million at a $5 million post-money valuation, the pre-money valuation is implicitly $4 million.
Historically, venture deals were often discussed in terms of pre-money valuation, but there has been a trend, especially in the startup ecosystems in places like Silicon Valley, towards using post-money valuation in term sheets because of the clarity it can provide.
In summary, while neither Pre or post-money valuation is inherently more founder-friendly, many argue that post-money valuation provides clearer terms and can be more founder-friendly in the sense of understanding and negotiating equity dilution. Regardless of which term is used, it's vital for founders to have a clear grasp of the implications and to ensure transparent communication with investors.
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There are other features we have added to the cap table template which you can use to create more specific funding scenarios. And although we can't cover the financial implications of each feature, you can research the definitions of each term by searching online or using an AI chatbot. As you learn about these features with your research, plug your hypothetical values into our template to see how the founder ownership changes over time in the Timeline and Dashboard tabs.
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As a startup progresses from the Seed stage to Series A, B, and C, its valuation becomes clearer, and Priced rounds occur. A Priced round is when investors purchase company shares at a set price because the valuation is well defined. Investors no longer rely on SAFE or Convertible notes; instead, they acquire Preferred shares.
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Preferred shareholders have a higher claim on the company's assets and earnings. They receive dividends before common shareholders, and in the event of a liquidation, preferred shareholders will be paid off before common shareholders. This makes Preferred shares a more attractive option for investors.
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After Priced rounds take place, founders and employees will typically own Common shares, and investors Preferred shares. And the combined count of Common and Preferred shares represent the total equity of the company.
As such, to create a founder friendly company, one needs to ensure that the founders either keep control of the company by owning the majority of the shares, or the founders are indispensable and can not be replaced.
Priced rounds also trigger the conversion of any outstanding SAFE or Convertible notes into equity in the form of Preferred shares. The convertibles, once just potential equity, now become actual shares. This increases the total number of shares and dilutes the percentage of the company that each share represents.
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For example, remember earlier in the article we mentioned that your uncle invested $10,000 in the company and received a SAFE note. As his SAFE notes become Preferred shares during Priced rounds, the percentage of the company owned by founders decreases.
But believe it or not, there's yet another source of founder dilution: the Option pool.
An Option pool is a block of shares set aside for future employees. It's a way to attract and retain talent by offering them a piece of the company. However, creating an option pool increases the total number of future Common shares, which can further dilute the ownership of existing shareholders.
The common rule of thumb is that the equity pool should represent 10 to 20 percent of company shares. However, this can vary based on the company's stage, industry, and other factors.
Investors often request the expansion of the option pool during a Priced Round. Why? By ordering the expansion of the option pool before the Priced Round, new investors ensure that the issuance of these new options does not dilute them. Their ownership stake remains intact, while the founders' and early investors' stakes are diluted.
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Let's see how these elements come into play in our ongoing Airbnb scenario. In our Series A tab, we'll enter our pre-money valuation, which is the valuation before any new investment is made. For our example, let's set this at $10,000,000.
Next, remember the seed round? The SAFE and Convertible notes we issued then need to be converted to shares. To do that, we select the two angel investors we had in the previous round, and both of the convertibles will be automatically linked. We must choose "Yes" to trigger the conversion in this specific round.
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Now, let's analyze how things would turn out for Airbnb with the entry of a new investor who wants an expanded option pool. They want a 10% option pool reserved for future employees and insist that this comes out of the post-money valuation. Consequently, the option pool dilutes the stakes of the founders and previous investors, not the new investor.
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Also, they are investing $5,000,000 at a post-money valuation of $10,000,000. Our template will automatically determine how many total shares they'll receive under these conditions. As we issue these preferred shares, the cap table updates accordingly.
The nice thing about this template is that you can, at any round, issue shares or notes at any valuation – by using the spreadsheet tab associated with the funding stage you're in. As you create Common shares, Preferred shares, SAFE notes, Convertible notes… among others, the graphs and charts in the Timeline and Dashboard tabs will be updated accordingly. That way, you can visualize multiple scenarios and identify at what point your company will ultimately lose founder control – or not.
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Understanding the dynamics of startup funding, from pre-seed to priced rounds, is crucial for founders. It's important to understand how different funding instruments work, how they affect ownership and dilution, and how they can be used strategically to grow the company while preserving as much equity as possible.
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Think about the story of Tesla versus Airbnb. Both are successful companies, yet at one point the control and direction of Tesla moved away from the original founders, and Airbnb's did not.
We've covered a lot of ground in this article, from the initial ownership distribution to the complexities of SAFE and Convertible notes, the impact of Option pool expansions and downturns.
We'd love to learn from you. If you're a founder in the startup world, share your stories with us! Or, If you work in the innovation space, are an investor, or simply have more knowledge in the topic drop a comment and let us know what else we can cover. Lastly, if you have any questions about the material we covered, ask your questions in the comments and we'll try to answer – assuming our investors give us the power to do so;
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