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Cap Table Math - How To Use It To Short On Profits
The cap table is a key concept to understand when discussing private investment. "One of the imperutable laws of venture capital investing is that, at any given time, there are just 100 possible transactions that can occur, out of which only one will lead to an investment in a project." This law is a fundamental rule in determining whether or not you should invest in a company based on its cap table value. By "investing", we mean raising funds by issuing stock in order to finance operations and development of a company. So, if you invest all of your savings in some great business startup, you'll be effectively locked into that business for the rest of your life.

That's why it's often uncomfortable to discuss cap table math with friends and acquaintances who've invested in multiple companies. Because of this discomfort, it's frequently recommended that entrepreneurs (especially new ones) begin financing their ventures using personal savings or line of credit, instead of traditional financing from banks. Why? Because it's a much more difficult process; because it takes longer; and because it presents additional challenges in terms of managing your cash flow.

The primary reason for being uncomfortable about financing a startup using your own money is that you are (ostensibly) interested in building long-term wealth. In that respect, cap table math shouldn't be much more complicated. And, as it turns out, it's not. You don't need sophisticated software to get the numbers. Here's why.

First, there's no magic number. Don't let anyone tell you that a certain funding scenario will work for you, because it won't. Every financial situation is unique, and investors who have made huge profits in the past can't guarantee that they will make huge profits in the future. So, there's no "magic" number. The reality is that cap tables, along with other types of sophisticated financial modeling, aren't meant for you unless you're prepared to learn a lot of hard, cold, real numbers.

Next, remember that cap table math isn't all about dollars and cents. Remember the classic college finance exam question? Where you had to calculate the cost of vacation, lunch, and drinks for four people? That's the beauty of Cap Tables and other forms of sophisticated financing. They help you calculate how many outstanding shares you should buy at a certain price.

But, remember too that this calculation can also be done for options, forward contracts, indexed derivatives, and all other types of derivatives. All you need is an understanding of how derivative pricing relates to other valuation methods - which is how cap table math helps you. Of course, the key ingredient is to understand the underlying asset. For example, if you are looking to sell a stock in Microsoft, you would first need to figure out what the price of Microsoft stock will be after it has gone public. You can't make this determination based on current stock prices alone.

This is where a simple post-money share cap table comes into play. Basically, the price of Microsoft's stock will be figured out based on its price when it is actually purchased by you or your broker. So, you know that Microsoft will probably go up in value after the purchase. The problem is figuring out just how much it will go up. In other words, using the recommended method for this sale, you multiply the price you paid for the shares by the number of outstanding post-money shares.

And there are even times when you simply want to increase your ownership structure without owning Microsoft. In other words, you are looking to add a new partner, such as a corporation or limited liability company. In this case, it would be impossible to use the recommended method of multiplying the shares by the number of outstanding shares. So, in order to determine the true value of a particular security, you need to make use of cap table management software and the services of an experienced stock broker. It is true that you will have to pay for this type of service, but in the long run, you will realize its benefits.
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