Let’s get on the same page: The “capital stack” refers to the legal organization of all of the capital placed into a company or secured by an asset through investment or borrowing. The capital stack determines who has legal rights to certain assets and income, who receives priority of payment in the event of an uncured default, and in which order each party may be repaid or given authority to take over or liquidate assets in the event of a bankruptcy. (source)
Now, if you search “capital stack startup” you’ll see more than a few articles, nearly all of which have the baked-in assumption that the company in question is being financed with venture capital.
Certainly, a capital stack is extremely relevant during a venture raise. With the number of lawyers, investors, founders, lenders, and advisors potentially involved a founder must be sure that their cap table and capital stack is in check. However, what about a capital stack that exists to align the company to the desires of a founder, and not the preferences of institutional investors?
When considering what a Founder’s capital stack might look like, not surprisingly, it’s essentially in direct opposition to that of a traditional venture-funded capital stack. Here’s what a typical capital stack looks like, according to Chessboard Capital:
Note that revenue is king. If you can generate revenue and bootstrap to success, you’ve just eliminated 3 of the 4 sections within the above stack, and you’re all that’s left when payday comes.
Even if you have to take out debt from cash flow, you’ve now eliminated two of the sections, and two players who are going to get paid before you do. Your new capital stack emerges like this:
Now, as you pay off that debt, obviously you become increasingly in a better position as a founder. Understanding your company’s capital stack is critical for venture fundraising - but it also provides insight into the fact that you may want to avoid it entirely.