Unpacking Cap Tables with Paloma’s Sebastian Cox: A Guide to Equity Mastery

Unpacking Cap Tables with Paloma’s Sebastian Cox: A Guide to Equity Mastery

When someone becomes a founder their world instantaneously changes. There are a multitude of decisions to make, perspectives to hold and responsibilities thrust into their world. 

These early days are crucial to building a solid foundation for a business that can attract investors and supporters, customers, advisors, talent, and ecosystem attention. But while many founders use their focus at this stage on product creation and development, growth, hiring, and pitching, one thing often gets glossed over—the elusive cap table. 

To quickly break it down, a capitalisation table, or a cap table, as it’s colloquially known, is a document that outlines who owns the equity in a business. 

TL;DR: It’s how founders track via a living record of who owns what portion of their company, which inevitably shifts and changes as a startup grows, scales and matures. And it’s massively important to the long-term health and success of a business. Ignoring it can lead to significant challenges as your startup matures.

Typically, as a startup raises additional capital from investors through fundraising rounds (think Pre-Seed, Seed, Series A, B, C etc), more and more pieces of the company become owned by investors, in exchange for an infusion of capital into the business. This in turn makes cap tables far more complex, as they reflect the increasing number of stakeholders in the business. 

It’s fair to assume then, that a startup raising their Series C round, has a good deal more people on their cap table than a startup raising a Pre-Seed round. And while more capital is a positive indicator of the viability of a startup, a neglected cap table can prove to be a large challenge if not addressed and maintained throughout the startups journey. 

To learn more, we sat down with Sebastian Cox, a startup veteran and Chief Venture Officer and Partner at the venture studio, Paloma, which boasts an impressive portfolio, recorded to be valued at +$250 million and has guided unicorns like Afterpay to grow and scale to their $39 billion AUD acquisition by Square. 

Cox shared his valuable advice for founders to set themselves up for success when it comes to company ownership structure, and importantly, how to avoid common pitfalls when structuring their cap tables. 

From Idea to Unicorn: Paloma’s Approach

Included in Paloma's outstanding portfolio, are groundbreaking unicorns like Afterpay and rising stars of the Aussie tech scene like T-shirt Ventures, Marmalade & Chemcloud. Providing first-class service to companies at such varying stages of growth could prove a formidable challenge, yet Paloma rises to the occasion. One may wonder, how is Paloma able to balance supporting both earlier and growth stage companies effectively? 

To understand that, we have to look at the model of Paloma as a venture studio.

Their business unit structure houses 3 distinct teams, Paloma Digital, Paloma Ventures, and Paloma Capital. Cox heads up the Venture team, which, lucky for us, we’re covering in this piece. The Venture team supports day one founders. Zero to 1 to 100. Turning ideas into a company and taking them to scale. This team typically sees client engagement span roughly 18 months, with the goal to get these companies in a place to hit one million annual recurring revenue (ARR), which they view as their proxy for success. Paloma Digital's fee-for-service model more closely resembles an agency. 

‍Cox remarked, “Compare that to a startup in the wild. It usually takes about three years.” 

Cox shared that each new venture Paloma works with receives their own in-house dedicated team and that team grows and scales with that startup. This interestingly, also how Paloma's engagement with Afterpay began.

When Afterpay first started working with Paloma, they were still a small startup, and have since grown and experienced the scaling wins and challenges alongside Paloma to achieve their massive success. Paloma’s first projects working with Afterpay was building their first mobile apps, followed by taking over the responsibility of building and maintaining all of their consumer-facing tech. This is a beautiful success story for both companies, as Afterpay still works with Paloma to this day, with roughly a team of about 30 embedded in the global unicorn. 

‍The road to Paloma 

Cox has been in startups for the better part of a decade. He started his career in London, working in product and growth, bouncing between a few very early-stage startups and incidentally ended up working in another venture studio, InMotion Ventures, which had a VC fund and a venture studio akin to Paloma’s model. Cox eventually relocated back to New Zealand, stepped into a product role at Paloma, and now leads their Ventures Team. 

From Paloma’s three main pillars, (Paloma Digital, Paloma Ventures, and Paloma Capital), the Digital team focuses on building products for any different types of companies, from existing startups to large corporates. The Venture team is focused on working with founders to turn day one ideas into world beating startups, and the Capital arm invests in the startups coming out of the venture studio alongside other investors with their VC fund.

Paloma’s philosophy is: high conviction bets - quality, not quantity.

Venture Studio vs. Venture Capital Firm: What’s the Difference?

Before we view making smart cap table decisions through Paloma’s lens, we need to discuss the difference between a Venture Studio (like Paloma) and a Venture Capital firm. Understanding this distinction is essential. 

For those not familiar with this space, the concepts of Venture Studio and Venture Capital could both seem confusing and similar at the same time. Exactly what do they do and what do they have to do with a cap table? 

A traditional venture capital firm provides capital, strategic, and funding advice and support to a startup in exchange for owning a portion of the startup. The amount provided can vary depending on the firm, location, stage of fundraising, and whether the VC firm in question leads the startup's fundraising round. 

To contrast, a venture studio, in exchange for an equity position on the cap table (in Paloma's case 15%) provides capital, product development teams, strategic support, advisory, back office support and anything a new startup needs to grow.

Paloma’s north star is to help startups, which start off and remain as their own entity, transform an idea into a company generating a million in annual recurring revenue (ARR). These startups typically raise money quite early on, while working with Paloma, and Paloma capital participates in those rounds. When, after typically 18-24 months, a startup is ready to ‘graduate’ from Paloma, they typically have one million in ARR, or a clear pathway to it, they're typically at or near a bigger series A round where they have enough traction to go out to the bigger VCs for capital. Paloma Capital will additional invest in these startups' subsequent rounds as well. 

From a founder’s perspective, a potential reason to consider a venture studio model is to increase chances of success. Startups coming out of studios have a 30% higher success rate, are more likely to raise external capital and reach $1M revenue milestones faster. 

‍“We've got great proof points of that early in the portfolio and some ones that are happening right now, which I'm super excited about”, Cox shared. 

Crafting a Long-Term Cap Table

Similar to the need for a long-term vision for a startup, thinking about a long-term cap table is imperative for founders to nail at the beginning stages of the startups lifecycle.

Here are Cox’s advice to avoid cap table common pitfalls: 

• Know the rules 
  • Some VCs have strict rules regarding the percentage they expect a founder to maintain at certain rounds. 
  • The reason for this rule? VC's want to be sure that founders are incentivised to be motivated for the long term. 
  • If a founder retains too little ownership during the early (e.g. Seed) rounds, because they’ve given away too much capital too early, then the available capital only further minimises in every subsequent round.
  • Inadvertently violating this rule can mean certain VC firms won’t invest in that startup.
  • This can become a challenge if a founding team has retained only 50% or less ownership of their startup at a Series A round. 
  • Taking it a step deeper, consider the waning motivation of a founder. By their next round, with another dilution of capital, the founder of this startup is only holding a very small ownership portion of this company. 
  • This could lead to minimised motivation of the founder to contribute to the startup. 
• Dilution awareness
  • When a founder decides to bring in external investors in, the capital is diluted by 15-20% for each subsequent fundraising round. It's important for founders to be thinking not just of this round but the ones following.
• Beware of dead weight 
  • This means people who are not actively contributing to the startup.
  • This could look like people who have been granted sweat equity, but those individuals are not actively involved in the startup at its current stage. 
• Watch for fence-sitters
  • Cox describes “fence-sitters” as people who are interested in joining the company and would like to take their equity piece but are unwilling to commit to taking the risk of joining the startup from day one.
• Allocate for Employee Share Ownership Plan (ESOP)
  • Some investors require as a condition of investment that an allocation of equity be placed aside for an ESOP so that key early hires who play a critical role in the business can be incentivised to stay.

Costly repercussions

Founders should aim to maintain the largest portion of ownership of their business, especially in their early rounds of raising capital, so that there’s room for dilution throughout the subsequent rounds of funding. Cap table issues are often identified as a lagging indicator, so it's important to be proactive and think about future scenarios early on to avoid complications later. The ability to recognise and mitigate against cap table red flags at the start of a founder’s startup journey, will allow them to avoid these capital landmines. 

While these pitfalls won’t ruin a startup's chances of ultimate success, especially if the startup has significant growth potential they can cause avoidable challenges later in a startup’s lifecycle. The silver lining? Ultimately, if investors are motivated enough to be part of a startups journey, they’ll find a way, even with a messy cap table.  

‍“There are ways around it, but you have to be getting a lot of other things right, in order to overcome (an unbalanced messy cap table). And that's why it makes sense to cover it off in the early stages. It will always be messy, just like building startups is an inherently messy process”, Cox remarked.

The Paloma Philosophy

Paloma’s goal when working with early-stage startups is to ensure that the company is palatable and looks good from an external investor point of view and recommend aiming for an optimal cap table state with a founder maintaining 70-90%, or a decent majority of the company early on. 

Founders can achieve this percentage and balance retaining control while also making room for investors from day one by thinking long term about their cap tables. The same way they plan for a long term vision or exit strategy.

As for Paloma, the studio’s dream state is to watch their portfolio companies continue to grow to  sizes much larger than themselves. With success stories like Afterpay, Marmalade, Chemcloud, and T-shirt Ventures, Paloma’s approach clearly works. As they continue to support and scale their portfolio, we can expect more impressive achievements from their ventures.