Notes

Post-Money Valuations and the Effect on Entrepreneurial Series D Capital and the Cap Table Model
Cap table modeling is a term that is often used by novice investors. However, it should not be misused as there are many advantages to buying the cap table as opposed to the common share. First of all, investing in the cap table is very attractive to many investors because they make more money when the market rises. The reason for this is that investors have more control on the prices of stocks. There are also tax advantages to owning the cap table.

As mentioned above, cap table modeling is a type of option that allows investors to invest in shares that have risen in price over time. When they rise in price, they are able to call their shares and buy them up at a discount or a "call" option. This is called a "call option" because it gives the owner the right to purchase shares at a set date and price within a set time frame. This is much less expensive than actually investing in the shares. The option expires when the time frame expires.

Another advantage to cap table modeling is the added stakeholder is created by the option grants granted to the buyer. With traditional options, there are only two possible outcomes: the investor will lose a lot of money or will profit a great deal. With the option grants in cap table modeling, a potential buyer can take advantage of the rising share value and either buy up the entire offering at a discounted rate or just acquire a small portion of the stock at a low cost. This has the effect of creating a secondary shareholder.

One of the most attractive features of cap table modeling is that it can lead to additional stakeholder benefit. For example, if the shares begin to increase in price before the option grants are held long enough to expire, an additional stakeholder will be created. In order for this additional stakeholder to be created, he must initially buy up an unlimited amount of the shares. As the number of shares purchased by the primary buyer increases, his profits from option grants will also increase.

Further, investors in cap table activities have the opportunity to add the value of their own capital to the mix. If they choose to do so, they will add a new customer to the equation. However, this added customer will not be required to pay the same taxes as the original customers. The profits made on these purchases by the secondary investors are subject to UBIT, which is deducted from the shareholders' tax returns.

In the early days of the business, it was not unusual for the founder's share of the company to be held by several investors. In many instances, these owners were not necessarily long term investors. It is not uncommon today for the founder's name to be added to the cap table of just a few investors. In addition, most investors typically know each other personally, which further insures that the investor's interests are safeguarded.

When a company completes a cap table transaction, the proceeds from the sale of the shares are usually provided to all shareholders, regardless of whether they have been shareholders for a year and a half. The proceeds are usually paid out immediately. However, it may be required that an additional payment be made if the company is not generating enough money to cover the costs of the transaction. If the company is not generating enough pre-money valuation of the shares to cover the expenses for the transaction, the company must accept a pre-payment from an external funding source. This occurs most commonly with private placements and has been implemented by almost every venture capital firm that I have ever served.

To date, there has been very little published research on how much these transactions actually cost to the startups that sell their shares. Most share prices are based on implied value, or the discounted future cash value (DCFV). However, the pricing model most venture capitalists and private investors will agree upon is the discounted per share (CPS) price, which is based on the actual market price of the shares at the time of the purchase. It is my opinion that this pricing model makes it significantly more affordable to raise capital from outside sources.
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