There's a Cap Table Problem in the Nordics

As a founder and angel in the Nordics, I have noticed one concerning trend: many early stage founders give up too much ownership of their business before they even hit Series A. This is a serious problem: the wrong setup on a cap table can hinder a startup’s growth and prospects for future funding. Generally speaking, founders and the core team should be concerned if they have less than 50% control of the company before they raise their Series A.

How Did We Get Here?

Inexperience on both sides - founder and investor - is at the root of this problem.

In Norway and in the Nordics in general, many founders are on their first venture and don’t have enough of their own money to start the venture. They must rely on outside investors, so sometimes lose sight of the consequences of giving up significant ownership in the business as they focus on simply getting capital.

Investors are often not experienced with early-stage companies. I believe that being first money in is simply a ticket to sit at the table when big investors come in at Series A. Yet many early investors don’t understand this; they become blindly focused on maximizing their absolute percentage of ownership early on.

The significant presence of university technology transfer offices (TTOs) — which help researchers and university staff commercialize potentially lucrative research — in the Nordics can also contribute to cap table issues.

I co-founded the educational gaming platform Kahoot! in 2011 with two co-founders and a TTO. We were very grateful for the help that the TTO provided in helping bringing our ideas to the world, but we ran into trouble with this ownership system when raising more money.

I remember an established and respected early-stage investor in London turning us down because they were uncomfortable investing in a company where the TTO owned a quarter of the company. They felt the TTO was limited in its ability to make a meaningful contribution as an investor. Our solution: we brought in an angel to take over the TTO stake. We felt that the angel would be a more active contributor to the business, but we unfortunately had not fixed the ownership structure. That just goes to show how difficult it is to fix a cap table!

Why is This Holding Us Back?

A heavily diluted founding team has less equity with which to attract big talent and keep stellar employees.

An unbalanced cap table is also a major concern for VCs. Rikke Eckhoff Høvding, CEO of the Norwegian Venture Capital & Private Equity Association explains it very clearly: “The venture capital industry is heavily dependent on founders having incentives to drive the business forward and not to leave ship when problems arrive. Investors invest in people, and they prefer a founding team that is capable and incentivized.”

It is the same story in Finland and Sweden, according to Harri Manninen, Founding Partner at Play Ventures.

“We at Play Ventures believe that founder equity should be distributed fairly among the active working founders and that the founders & early team, who are the value creators should capture a meaningful amount of the upside. Having angel investors with more equity than founders, or part-time passive founders, can lead to resentment and a misalignment between commitment, risk and reward,” Harri says, continuing:

‍“Some early angel investors, accelerators, etc. absolutely may have a significant value impact in the beginning and have a place in the ecosystem. But their share of equity should not be outsized in a way that would hinder the future growth and fundraising opportunities of a company - which would also be a problem for them.”

What Can We Do About It?

Founders can consider buyback schemes - it’s better for investors to own less of something big than a lot of nothing. Investors should know that if they sell back part of their shares for a nominal return to the founders or to new investors, they are setting the company up for success and themselves up for potentially even greater financial returns.

In the case of TTOs, they are still of course an important part of getting great research ideas off the ground. But I believe that licensing agreements, where TTOs get paid at success would be a better incentive for both founders and universities.

But these solutions can be challenging. To quote Rikke again, “there are few solutions to a messy cap table — you have to do the right thing from the start. If you try to redistribute shares, there will be tax issues, and if you try to rectify with options, this is very costly from a tax point. So it really makes sense to spend time getting this right from the start.”

But of course, the best thing is to simply avoid the problem from the beginning. Harri from Play Ventures says:

“In our experience, even though early involvement is essential to get things going swiftly, most of the true value creation is done over several years and through all of the lessons learned together as co-founders and key persons of the company. That is why with founders we like to see a multi-year commitment and longer vesting cliffs than what perhaps has been standard in early stage VC. We also believe that advisor shares should definitely be subject to vesting against well-defined advisory commitments.”

My Advice to Angels

(1) Think hard about how much you want to invest and at what valuation: Remember, it’s not all about ownership, but investing with the company as it grows. With that in mind, I think it is usually better to invest less than you originally budgeted for and save some for follow-on. The valuation at which you invest is also important — the wrong valuation will manifest itself in the cap table and it will be hard to sort that out later on without running into issues.

(2) Spend time with the board and founders before investing and ask them to make a funding roadmap: Making such a document will help them become aware of potential issues with the ownership structure down the road and avoid them before it becomes a problem.

(3) Don’t consider it a bad thing if the first institutional money in the company (a VC most likely) wants to buy out your stake: When VCs come into the picture, they are often better positioned to give the better advice and support to the company at that stage than an angel. Angels shouldn’t feel that losing ownership is a blow — you’re receiving a financial gain for stepping away!

(4) Think about the contribution you can make by potentially nominating an external representative to serve on the board instead of yourself: It’s always a red flag to me when I walk into a VC-only boardroom. Boards make better decisions when there is diversity of thought and insight. One way that angels can set founders up for success in the boardroom is by nominating someone external to the board to represent them. Maybe that’s an expert from the same field who will be crucial in advising the firm. Not only will you help strengthen the board, you also have a chance to contribute to making the company more diverse by nominating someone from an underrepresented background.