Too often, SaaS and AI founders focus on the amount raised, rather than the structure behind it. That structure, known as the capital stack, determines who owns what, who gets paid first, and how much control you retain over your company.
In volatile funding markets, where terms are tightening and capital is more expensive, capital stack literacy gives tech founders a critical edge. Knowing what to consider when building your cap table and what critical mistakes to avoid can help you extend your runway while ensuring you structure capital in a way that supports long-term growth, team ownership, and strategic flexibility. Here’s what you need to know to set yourself apart and manage the capital stack like a pro.
Capital Stack 101: Understanding Capital Stack Layers
The capital stack refers to the hierarchy of funding sources a startup uses to finance its operations and growth. Understanding how these layers interact is critical, as each type affects your company’s risk profile and your influence as a founder.
Debt Layers of the Capital Stack
Debt financing takes first priority in repayment, so visuals tend to illustrate it at the bottom of the capital stack. Early-stage startups likely won’t qualify for debt capital, so it’s best suited for post-Series A, when there is predictable revenue, strong metrics, and a clear path to profitability.
- Senior debt: Senior debt gets repaid first and offers low risk to lenders, making the cost of capital lower. Senior debt also requires strong cash flow or collateral.
- Subordinated debt: Subordinated debt (also called junior debt) offers more flexibility than senior debt and typically comes with fewer covenants. The trade-off is that it often carries higher interest rates and still requires regular repayments.
- Mezzanine debt: Mezzanine debt provides capital without immediate equity dilution and may delay payments. The drawback: it’s an expensive form of capital and often includes equity kickers, which can reduce long-term founder ownership.
Equity Layers of the Capital Stack
Pre-seed companies typically do not qualify for debt financing. Instead, that’s when you look for founder equity and raise with friends and family. In your pre-seed round, you might turn to angel investors or early VCs (common or preferred stock), and institutional VCs will likely play a larger role in your Series A-C+ (often preferred stock with terms like liquidation preferences and board rights.
- Preferred equity: Preferred equity gives investors priority over common stock in terms of distribution, but it doesn’t typically offer voting rights. Preferred equity offers investors a higher potential return than debt, with less risk than common stock.
- Common equity: Common equity is typically held by founders and early team members, allowing maximum control and upside, but it’s the last to receive returns and can be heavily diluted depending on what funding choices you make.
Avoid Unwanted Dilution With Smart Structuring
Your earliest startup funding will likely rely heavily on equity. From your pre-seed to Series A, friends, family, angel investors, and VCs will often invest in exchange for equity. This is the best deal for new SaaS and AI companies for two reasons.
First, putting the pressure of repayment on a company that hasn’t yet solidified its product-market fit and go-to-market strategy is like stomping on a seedling - it can easily kill it. Second, you don’t yet have any revenue, time in business, or a business credit score (the typical qualification for business financing).
It’s important to remember that equity isn’t your only option for capital. Once you’ve established predictable revenue, you can start leveraging debt to increase your working capital without additional dilution.
SaaS and AI startups with predictable revenue can leverage options like revenue-based financing to fuel growth without giving up ownership. Revenue-based financing gives you capital upfront to extend your runway in exchange for a percentage of future revenue until the loan is repaid.
Pete Keenan, VP Finance at 645 Ventures, advises founders: "There’s a point in every SaaS or AI company’s growth where debt becomes a powerful tool, but the timing matters. Take it too early, and it can sink you. Use it when you have predictable revenue and a clear growth path, and it can be incredibly accretive."
Startups with predictable revenue can also take on venture debt, which is similar to a bank loan in cost of capital and steady repayment terms, but keep in mind that instead of using traditional collateral, venture debt typically uses warrants for company stock (giving the lender the ability to purchase company stock at a set price over a set period).
More ways to protect yourself from dilution: Keep a strong common equity reserve for the founding team and employees to ensure long-term control and alignment. When raising equity, work to negotiate preferred equity with founder-friendly terms, like capped dividends. You can also pursue strategic partnerships or corporate VC, which may offer capital with less aggressive dilution terms.
Four Mistakes to Avoid When Building Your Cap Table
These are the most commonly overlooked considerations when building your cap table.
- Over-allocating equity too early: Founders often give away too much equity in early rounds, leaving little room for future hires or strategic investors.
- Not reserving an adequate option pool: Failing to set aside a sufficient option pool can hinder hiring top talent and force painful cap table adjustments later.
- Underestimating dilution from SAFEs/convertible notes: Deferred equity from SAFEs and notes can cause unexpected dilution when they convert, especially if multiple rounds stack up.
- Lack of scenario modeling: Many founders don’t model different fundraising or exit scenarios to understand how ownership and proceeds are affected over time.
Pete Keenan of 645 Ventures adds, “Before founders kick off their next fundraise, we work with them to map out how their cap table will evolve across future rounds and outcomes. Seeing those scenarios upfront helps them shape a smarter raise - one that balances growth with long-term ownership and control."
Extend Your Runway With the Savvy Capital Stack Decisions
Your debt/equity mix determines how much capital you can access, how long it lasts, and how much control/future optionality you’ve either retained or given up. A well-structured capital stack allows you to control burn rate, preserve equity, and time fundraising around strategic growth, rather than desperation.
Top 10 tips for using your capital stack to extend runway:
- Mix debt with equity: Use venture debt or revenue-based financing in combination with equity to fund growth without immediate dilution.
- Delay valuation with convertible instruments: Use SAFEs or convertible notes early on to raise capital without setting a low valuation too soon.
- Time fundraises around milestones: Raise capital after hitting key product or revenue milestones to justify better terms and higher valuations.
- Negotiate favorable terms: Push for non-participating preferred equity, capped 1x liquidation preferences, and limited anti-dilution clauses.
- Use non-dilutive sources of capital: In addition to non-dilutive debt, you can apply for grants, R&D tax credits, or competitions.
- Optimize burn rate: Align capital structure with a lean operating model to reduce how much capital you need and how quickly.
- Layer capital strategically: Introduce mezzanine debt or structured equity at later stages to fill funding gaps without excessive dilution.
- Keep control of the cap table: Avoid over-allocating equity early. Reserve shares for future hires and investor rounds.
- Explore strategic investors: Corporate or strategic investors may offer capital with less pressure and longer-term alignment.
- Monitor Covenants & Repayment Terms: Ensure any debt financing has terms that align with your cash flow and growth timeline.
Start Building Your Capital Stack Literacy Today
Ultimately, capital stack literacy isn’t about finance for its own sake - it’s about keeping more of what you build, staying in control as you scale, and building a company that can thrive through any market cycle. Start building yours today with ECL’s cost of capital calculator, SaaS valuation calculator, and SaaS growth calculator.
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Capital Stack FAQs
The capital stack refers to the hierarchy of financing sources (debt and equity) that fund a company, ranked by repayment priority and risk.
Capital stack literacy is the ability to understand, evaluate, and strategically manage the different layers of financing to optimize funding and ownership.
Senior debt holders are paid first in the capital stack, followed by subordinated debt, preferred equity, and finally common equity.
A cap table (capitalization table) is a spreadsheet or tool that shows a company’s ownership breakdown, including shareholders, share classes, and equity percentages.
SAFEs (Simple Agreements for Future Equity) are startup financing instruments that allow investors to convert into equity at a future event without accruing interest or requiring repayment.
Convertible notes are short-term loans that convert into equity at a future financing round, typically with interest and a valuation discount or cap.
Structured equity is a flexible financing tool combining elements of debt and equity, often used in growth or late-stage funding to balance risk, return, and dilution.
Mezzanine financing is a hybrid form of capital that blends debt and equity, offering high returns to investors and flexible funding to companies (often with warrants or conversion rights) while carrying more risk than traditional debt.
Equity financing is the process of raising capital by selling ownership shares in a company, providing long-term funding without repayment obligations but resulting in dilution of founder ownership.
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