Notes

What Is The Capital Table And Why Is It Important?
A Capitalization Table shows the financial metrics associated with a business. It provides information needed to evaluate a business's liquidity. The best way to describe a capital table is a pie chart that shows the different relationships among the different components of the business. The most significant component in any given capital table is equity. The other contributors are debt and retained earnings.

To show how equity relates to capital structure for a given company, first consider equity as a percentage of ownership or alternatively called ownership. There are two ways to think about ownership and to represent it in a business: total assets or tangible assets. Total assets usually refers to the current value of the company's stock and includes long-term bonds, preferred stocks, common equity, and common equity securities. The other way to think of ownership is on an individual basis, for example, the difference between total assets and employee stock or retained earnings. Equity dilution is the increase in value of the owner's shares over time as a result of dividends paid or share purchases and is expressed as a ratio of dividend payment per share times the total number of outstanding shares.

A capital table shows the relationship between total shareholders (owners) and retained earnings. The concept behind this is that if retained earnings represents a company's future profits, then total shareholder's equity is equal to the value of all of the company's pre-existing profits. To simplify this, if there is one shareholder that owns 100% of the company, then he has 100% share holdings of the company. Likewise, if there is no shareholder and there are two equally-ownersed shareholders, then their share holdings will be multiplied by the total number of shares of each shareholder. The capital table can be visualized as a pie chart with one pie segment representing each of the shareholders.

There are several ways to calculate a capital structure including using the latest ratios of dividends to retained earnings, net income attributable to the owners, the relevant information from the public register, third-party capital injections and private placements. Capital tables can also be calculated by using the ratios of net capital contributed by the startup to the total retained earnings. This can be calculated as NRT(company's current gross cash flow / current gross cash) x 100.

However, one issue that many people have when they're calculating their own capital structure is that it really is very confusing. Because of the cap tables and the whole notion of EBIT, or Expected Company Tax Paid, it's really hard to determine whether an acquisition is going to be tax-free or not. When you've got an acquisition that is valued at one penny, do you really think it's going to be taxable? This really is very difficult to figure out and many startup s get themselves into trouble by ignoring the capital structure.

Often times, investors will think that because an acquisition is very cheap, the employees are going to be owners. This is completely untrue and this can often lead investors to make bad investment decisions. The whole idea of the cap table is to determine the ownership structure of the business and it really was created for the sole purpose of funding IPOs. Investors are really only concerned with one number: the net present value of the purchase price. They don't care whether or not the company is actually worth one dollar or ten dollars. All they care about is what they could get from it if they make an investment.

The problem with this is that they often overlook the fact that the total cost of capital is much less than the cash value. Also, the option pool is used to limit the liability of the shareholders so that they only really pay out their investment if they're right. Unfortunately, this means that if the company goes under instead of making a profit, the shareholders are stuck with nothing. The capital table limits this liability and investors will tend to be much more conservative when they make an investment in an acquisition.

However, this doesn't mean that the cap table isn't used at all. Many startups utilize the option pool to limit the liability of the equity compensation and still meet their obligations to investors. Many investors also use the cap table because it limits their liability and makes raising additional capital that much easier. Capitalizing on this type of business is a matter of understanding how it works and how you can make use of it to your benefit.
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