Notes

Understanding Cap Table Math
startups of the most common misconceptions about venture capital funding is that it is a black box. "How do we know what the fund managers have?" "They said they want to use proprietary software... What does that mean?" Unfortunately, most angel investors think in terms of those things and miss out on the important questions that really determine whether or not a prospective funding candidate is worthy of their investment capital. It is unfortunate that those that are closest to the venture capital funding experience are the ones that usually ask these questions.

If I told you that most venture capitalists had no idea how to judge the value of their investments, you would probably think me crazy. In my experience, though, it is true. The whole process of raising venture capital is largely a mystery to most fund managers and investors. One of the ironclad rules of venture capital financing is that there are just 100 shareholders (the venture capitalists). As one of the largest numbers in the group, they have a tremendous amount of influence over the valuation of a company and the ultimate success or failure of that company.

When you add up all of those individual ownership percentages and you multiply them by the total number of shares you own, you quickly arrive at the value of your stake in the business. That number is called the diluted share value (or PV). This number is often referred to as the cap table in the investment community. You have probably seen it used many times in investment presentations and in legal documents, but you may not be aware of its definition or its importance in the overall valuation of a business. It is the basis for determining whether a private investor will lose his investment in a venture. If the invested funds drop below the threshold that represents the dilution of ownership, the venture capital fund manager must give back some of his investment.

Why is it that many people are uncomfortable when it comes to asking the question: What is the cap table? It is a question that is frequently uncomfortable, but one area where the smart money is often made is in the venture capital field. Many venture capitalists are savvy enough to know that they need to keep their options open as far as who they might invest in if their preferred investment scenario doesn't work out as planned. The best way to keep an investor from watering down his expectations with overly optimistic numbers is to keep him well-informed about the risks and rewards of each financing option he might consider. The best way to do that is with a complete and comprehensive cap table.

A cap table is a comprehensive chart showing the cost of each capital raising transaction, including the value of shares allocated to each individual member, as well as the potential upside and downside value of that transaction for the owner. In startups , the actual shares allocated to an investor are disclosed for the year the business was started and for the expected life of the business. However, in the case of companies that are still growing, the shares may be allocated in full or part on a year-to-year basis. Investors must keep this fact in mind when reviewing potential funding sources.

The key to making a good cap table is to focus on the total cost, which includes the price of shares, as well as the potential upside if those shares are acquired. One way that new investors can make their math easier is to focus only on the value of the acquisition. This calculation includes the price per share for each purchase and assumes that the total number of shares will be determined at the start of the business. The value of future ownership stake should also be taken into account. Usually, startups presents the venture capital partner with a written offer to purchase all or a portion of the new shares of ownership in the company.

startups in understanding and using a cap table is to determine the appropriate methodology for calculating the value of post-money shares. startups use the book value of the company's stock as their preferred measurement method. The advantage of this method is that it is based solely on current market prices, so it provides a more accurate picture of the actual value of the company's shares. However, many entrepreneurs do not use this as their preferred method because it does not factor in possible future dilution of its shares. As such, it is often times used as a means to obtain financing without considering the long term consequences.

Cap Table Math is an integral part of being a successful entrepreneur. It helps entrepreneurs focus on things like potential expansion opportunities as well as acquiring and maintaining desirable shares in the business. This math can be performed in a number of different ways, including direct purchasing of shares from the company, by purchasing company options, or indirectly through private placements. Regardless of how the numbers are derived, it is important that they are calculated carefully and then compared with the overall market. Following these steps will ensure that you have a clear picture of what should be happening with your business.
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