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Hi, I’m Dima, founder of PitchBob, an AI co-pilot for entrepreneurs, and EUquity.com — an EU-focused equity management platform. We help founders craft their startups’ narratives and materials, preparing them to attract investments and properly set up their cap table.
When building a startup, founders often focus on product development, raising funds, and scaling their business. However, one critical factor that can silently undermine even the most promising venture is a broken cap table. This term refers to a situation where the equity structure of a company is misaligned, leaving founders with a dangerously low percentage of ownership.
Let’s explore what a broken cap table means, why it happens and how to avoid it while highlighting common mistakes and actionable solutions.
Related: 12 Rules Entrepreneurs Must Know About Cap Table Management
1. Excessive dilution of founders’ equity
A cap table, short for capitalization table, is a detailed breakdown of who owns what percentage of your company. It’s an essential document for understanding equity distribution among founders, investors, employees and other stakeholders. A broken cap table occurs when founders’ ownership drops to unsustainable levels, typically below 20-30% by Series B or C funding rounds.
For example, at the seed stage, founders’ holdings dropping below 50% can signal the start of dilution problems. By Series A, founder ownership under 40% is considered risky, and by Series B or later, ownership below 20% is a clear sign of a broken cap table. These thresholds highlight when founders lose substantial control and influence, which can deter future investors and limit a startup’s ability to succeed in subsequent funding rounds.
2. Demotivation of founders
A broken cap table is not just a numbers problem — it has far-reaching consequences for your startup. When founders’ ownership is too diluted, their motivation to drive the business forward diminishes. Significant equity stakes are vital for ensuring long-term commitment and strategic decision-making. Investors also look for motivated founders with meaningful stakes in their companies. If founders’ equity falls below 20-30%, it signals potential mismanagement and reduces confidence in the team’s ability to stay fully invested in the venture.
3. Investor hesitation
A broken cap table can scare off new investors. They may hesitate to invest if they see that the existing equity structure is unsustainable or overly diluted. Offering competitive equity to attract and retain top talent also becomes challenging when the cap table is already stretched thin. This can severely impact your ability to build a strong, dedicated team. In addition, early investors holding too much equity may exert disproportionate control, leading to governance problems and limiting your strategic flexibility.
Related: The Trick to Splitting Startup Equity Among Key Players
4. Inability to attract top talent
Several factors can lead to a broken cap table. Accepting too much funding in the early stages often results in excessive equity giveaways before the company has significant valuation growth. Poorly negotiated terms with investors, such as high liquidation preferences or anti-dilution clauses, can disproportionately harm founders’ equity.
Failing to forecast equity needs for future rounds and employee stock options can lead to severe dilution over time. While having multiple co-founders can be an asset, splitting equity too thinly at the start can cause issues in later funding rounds. An inadequate or poorly planned employee stock option pool leaves little room to incentivize employees effectively.
5. Governance problems
To avoid a broken cap table, founders need to plan equity distribution strategically. Working with financial advisors or lawyers to create a long-term equity allocation plan is critical. Reserving enough shares for future funding rounds and employee stock option pools is essential. Founders should also avoid over-raising in the early stages and focus on raising amounts aligned with their current milestones and growth projections.
Negotiating wisely is equally important. Founders need to be cautious of investor terms that may lead to excessive dilution and should seek professional advice to understand the implications of term sheets. Early-stage startups can also consider instruments like convertible notes or simple agreements for future equity (SAFEs) to defer valuation discussions until later stages, reducing immediate dilution.
6. Disproportionate influence of dead equity
If a cap table is already broken, there are steps that can be taken to repair it. Equity restructuring is one approach, where founders negotiate with existing investors to adjust terms or dilute non-critical stakeholders. Downsizing future rounds and focusing on raising smaller amounts in subsequent funding rounds can also help limit further dilution. Allowing founders to sell some of their shares in secondary sales can provide liquidity and balance incentives. Working with strategic investors who understand the need to correct cap table imbalances and are willing to structure deals accordingly is another viable option.
Related: The Legal Viewpoint: What Startup Founders Raising Capital Need To Know About Term Sheets
7. Logistical challenges and inefficiencies
One of the most common mistakes startups make is giving up too much equity too early. For example, if first investors hold more than 50% equity in the early stages, it signals a loss of control for the founders. To address this, founders can explore non-dilutive funding options, use convertible notes or negotiate future stake reductions. Similarly, in deep-tech spinouts, universities often take ownership stakes exceeding 25%, especially outside Europe. This level of ownership can limit growth potential. Founders should negotiate these stakes down and explore other forms of giving back to the university, such as licensing agreements or revenue-sharing models.
A broken cap table can be the silent killer of even the most innovative startups. By maintaining sustainable founder ownership through each funding stage, startups can ensure their long-term viability. Planning strategically, negotiating wisely and staying vigilant are critical to protecting equity and fostering growth. Remember, your cap table is more than a spreadsheet — it’s the foundation of your company’s financial health and future potential.
