I often hear comments from entrepreneurs who are concerned with the idea of having thousands of shareholders on their cap table. Why is that? They have different reasons for it, and I thought it would be helpful to explore these concerns. Before I answer, you should know that StartEngine has over 20,000 shareholders on its cap table, and we’ve received numerous benefits by having this many shareholders. I will explore those too.
What exactly is a cap table?
A capitalization table is a list of shareholders and the respective number of shares they own in a company. The table typically includes the founders, investors, and holders of stock options and warrants who are not yet shareholders but may exercise their options in the future (which would in turn dilute the percentage of the total stock owned by the existing shareholders). If a company has issued warrants, SAFE (simple agreement for future equity) notes, and convertible notes, they are also added to the cap table. Any obligation to issue shares would be included in the cap table, so existing and prospective investors can get a clear idea of the ownership and the potential future dilution.
As a founder, it is very important to maintain a “clean” (or an accurate and up-to-date) cap table at all times. Companies use cap tables to raise funds, and the different ownership percentages of different parties on the cap table typically determine the most critical events in a company. These events include the amount everyone is paid when there is an exit event, who votes on what issues and other rights that come with ownership in the company. The cap table must also be presented to auditors, when the time arises for financial reviews.
In essence, this document helps the reader understand how a company was financed, who the other investors are, and the percent interest in the company the founders, management team and employees could end up with in the future. It is critical that those who work 24/7 to build a company from the ground up have a sufficient amount of capital to keep them focused and motivated to keep charging ahead.
Employees and a few investors on a cap table is one thing, but when you add thousands of shareholders to the equation, that document reads long, and entrepreneurs become worried that this is a concern to venture capitalists.
Note: it is worth pointing out here that generally most Reg CF issuer cap tables will not list all of the shareholders, but instead will have a general row for the number of shares issued in the Reg CF offering. Additionally, companies will engage a transfer agent, such as StartEngine Secure, to handle record keeping. In other words, having a significant number of shareholders on the cap table is not a burden to founders.
Do VCs prefer less shareholders?
Some entrepreneurs fear that VCs tend to prefer a short list of shareholders composed of professional investors rather than a long list of individuals who are not employed by the company. Why would VCs be concerned about the number of shareholders on a company’s cap table?
One reason involves risk. Some VCs may believe ordinary investors carry more risk because they could sue the company, and create trouble even though they only own $1,000 worth of stock. Although this is such a risk, we have not seen this in the last 4 years since the start of equity crowdfunding.
Many companies that currently issue shares to ordinary investors also implement proxy voting. This is a way to make sure the founders have control to make important decisions such as raising more capital and selling the company, which requires the approval of a majority of the shareholders. Since holding a proxy vote solves this issue, what other reasons could VCs have for preferring less shareholders on the cap table?
Another reason is transparency. A company that raises capital using equity crowdfunding must make their financials for the previous two fiscal years publicly available. This requirement may concern VCs who prefer to keep their investments, capital structure and performance measures close to the vest, and only want important company information to become publicly accessible when the time is right.
Typically, VCs will have a seat on the board, and have special shareholder rights, which include the ability to approve any new issuance of shares in the company. As such, they may not want the world to know which rights they’ve been granted. However, transparency has many benefits for customers and employees. It builds trust, and ensures management is held accountable for their actions. We believe venture capital and equity crowdfunding can work in tandem if venture capitalists value such transparency.
At StartEngine, we’ve been able to leverage the transparency that comes with equity crowdfunding to our advantage. By publishing our financials, we are able to share exciting company updates with our shareholders and our community to strengthen our relationship with our users and to build marketing momentum (it can be particularly helpful to combine those business updates with a live equity crowdfunding campaign).
We prefer the crowd
The reasons we decided to raise capital from the crowd include:
- We value our independence and ability to grow our company without outside interference.
- We don’t mind publishing our financial statements so everyone can see our performance. We allow the crowd to publicly comment on our offering page, which gives them a voice with regard to how the company is run. And we actively engage with the feedback we receive. In essence, it is the crowd that holds us accountable for our decision making.
- Our shareholders are some of our most valuable community members.
We have found great value in having around 20,000 shareholders. For example, we asked our investors to contact the U.S. Securities Exchange Commission to comment on a proposal and support changes that would benefit StartEngine and the rest of the industry. Over 50 of our shareholders sent individual letters on our behalf asking for those policy changes. We were able to mobilize our shareholders to lobby political groups in order to influence company policy that would benefit our business.
Another example of the value our shareholders provide is through our Scout Program, where dozens of our shareholders have referred many viable businesses from their respective communities to our platform. This is an amazing authentic expression of how they truly feel about our company. They are thinking about us outside of their direct interactions with StartEngine and referring other entrepreneurs that could benefit from using our platform. For us, returning to the traditional VC investment process is no longer an option.
StartEngine shareholders are not only owners of our company, but they are also the most active investors on our platform. We have seen this happen for other businesses listed on our platform, as well. When people believe in a company so much that they choose to invest in it, they have a personal stake in its success. In turn, they are more loyal to the brand and tend to spend more money than non-shareholders. Their lifetime value is higher, and in some cases, it is greater than the cost of the equity a company sold to them.
The future has spoken. Shareholders have become a critical part of building and growing a great business, not only through investment, but also by adding considerable value to a company over its entire lifespan. And, the more shareholders the better.
Howard Marks is the founder and co-chair of StartEngine, Los Angeles’ largest startup accelerator, determined to make LA a top tech entrepreneurial city. Marks was the founder and CEO of Acclaim Games (now owned by Disney), and the co-Founder of Activision and Chairman of Activision Studios (1991-1997).
To learn more about StartEngine, visit https://www.startengine.com/.