Notes

VC Cap Table Calculation For New Investors
"What is your cap table?" That's the question I hear most often as I prepare consulting presentations for potential clients, and one of the first things they want to know. Unfortunately, it doesn't help the answer to the question much. This article presents cap table terminology and explains what it means in the investment world.

The cap table is a summary of the company shares that an investor has decided are worth his or her investment. The term is used almost as often as the term "couple's share." One of the immovable laws of venture investing is that there are usually only 100 shares on the cap table. Any stock that more than that is called an out-of-the-money share. Outstanding shares are those with the lowest market values.

The purpose of the cap table math is to determine if an underwriter is justified in making such an investment, assuming that the underwriter can raise the capital amount required. For example, if a private company needs a infusion of cash to finance a start up, one could calculate the maximum value of the shares that can be raised by using a cap table. Based on previous figures, about 30 percent of start up ventures are funded within the first year. Assuming that those companies have a funded status within the year, the number of shares that can be raised would be approximately four percent. That percentage is low, but it is still a good representation of what investors in pre-money funding rounds consider their limits.

Most venture capitalists evaluate valuation based on net income (the income from book sales less capital expenditures). A cap table math calculation can be used to determine an acceptable Ebit and further evaluate the financial strength of the company. It is important to remember that most private companies do not have the capital needed to support a multi-million dollar initial public offering, which limits their ability to raise additional financing through other means. However, some private companies do have sufficient funding to support a medium sized initial offering. If the company intends to raise more money post-money than its current Ebit is worth, then it would need a substantially higher Ebit.

Private investors are typically not looking for a bargain basement share price. They are looking for good value for money. Therefore, it is critical to use accurate post-money valuation metrics in determining the value of shares for purposes of determining whether to make an offer and how to price the business. Private company founders using incorrect data can jeopardize their investment and the ability of their company to raise additional capital. Incorrectly valuing a company could also result in a costly venture.

Private company founders who underestimate the value of their shares may encounter challenges when they try to raise capital from venture capitalists or angel investors. Investors are not interested in companies that are worth very little and which struggle to generate profits. In order to attract a high volume of interest, potential founders will have to provide hard numbers with a supporting business plan. This becomes doubly important if the shares are initially valued using cap table calculation methods.

Private company founders who underestimate the value of their shares can experience significant challenges in securing seed investors or obtaining a loan from banks or credit unions. The potential losses from underpricing the company's shares can be mitigated if the company provides a strong business plan with an exit strategy. This is especially true if the company plans to sell the company at a significant discount to its book value after one or two years of operations. If the company does not intend to provide any direct financial support to the startup , then the only way to correct the valuation is to provide the funds needed to pay for a full year of operations. This requires founders to calculate a long-term cap table that takes into account both immediate and future capital expenses.

Due to the technical nature of VC cap table calculations, many new investors do not feel comfortable attempting them on their own. Many experienced entrepreneurs prefer using specialized software to make these computations. A good investment software package will allow you to generate accurate and reliable estimates of share price. It will also provide details about all of the major costs associated with a business like rent, startup investment, equipment and labor. This information allows new investors to focus on acquiring enough startup capital to support the growth of the business rather than worrying about whether they are overpricing the company.
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