The cap table is essential to understand the equity ownership and capitalization structure. It typically contains detailed information about the company’s individual and institutional shareholders, including their number of shares and the amount paid for those shares.
You can use a cap table to know how much new investments will increase the company’s current valuation. Investors need this information to understand how much of the company they’ll be owning should they push through with their investments. Here are how you can interpret the contents of a cap table.
1. Know The Basic Contents
The primary contents of a cap table indicate the capitalization structure of a startup Small/Medium Enterprise (SME) or corporation. The capital structure of a business is composed of the company’s ownership. This can be categorized into different classes of securities, such as preferred shares, common shares, convertible notes, and warrants. Here are some of the typical contents of a cap table:
- List of founders/incorporators and their shares;
- Names and other details about other equity owners;
- Prices paid by investors per share;
- Classes of shares (preferred, common, etc.);
- Convertible notes;
- Pre-money valuation; and
- Post-Money valuation.
Investors must be able to make sense of the contents of a cap table. They can keep track of their ownership share in a company by looking at the cap table. The percentage of their number of shares about the company’s total shares is the most accurate indicator of how many portions they own in a company.
2. Understand The Important Terms
To be able to interpret a cap table correctly, you have to understand the critical terms it contains:
- Debt. Money owed by a company to lenders with a stipulation for interest payment.
- Equity. Ownership of an individual or institution in a company in terms of shares of stocks.
- Common Stock. Owners of this class of stock are entitled to receive dividends declared by the company. They’re also entitled to vote for the Board of Directors.
- Preferred Stock. Owners of this class of stock are entitled to receive dividends and given certain privileges over common stock shareholders.
- Stock Options. This gives some shareholders to buy a specified number of shares, usually at a discounted price. Some employees are given this option as part of their employment package.
- Warrants. This is similar to stock options, but they’re not part of a stock option plan.
- Pre-Money Valuation. This is the company’s valuation before new investments come in or before a round of fundraising.
- Post-Money Valuation. This is the company’s valuation computed after new investments are factored in, usually done immediately after a round of fundraising.
- Price Per Share (PPS). This is the price of a shareholder’s investment per unit of share. After adding the new investments or equities, it’s computed by dividing the post-money valuation over the total shares.
- Convertible Note. This is a special kind of debt that you can convert into equity. The note holder can convert the note into shares of stock at some point in time when the note matures.
3. Know-How To Use The Different Formulas
Owners and investors should know how to use the different indicators and at least the different basic formulas to interpret the cap table.
Elements Of Capitalization Structure
Shareholders and investors should take note of the elements of a company’s capitalization structure so they can interpret a cap table correctly. Some of these essential elements are the following:
- Total authorized and outstanding stocks of a company and their individual or institutional shareholders, including the number of shares owned and the percentage of total outstanding stocks.
- Total shares of the founders and incorporators. Venture capitalists (VCs) suggest that they should always own ideally somewhere around 80% of a company before seeding and 67% before any series A round of financing. This is to make sure they have enough stake in a company to stay motivated to succeed.
- Treasury shares – These are shares that are part of the total authorized stock of a company that it bought from shareholders. They are factored in computing for the dilution of ownership.
Investors who have signified their interest or have already bought in should have a clear picture of the post-money valuation of a company’s capitalization structure. This is computed by adding the current pre-money valuation to the incoming equity or the number of new investments raised during the fundraising.
The post-money valuation is crucial information because it serves as the divisor in computing the percentage of an investor’s shareholdings with the total equity ownership of the company.
For example, if the company’s valuation increased from USD$10 million to USD$12.5 million when the new investor comes in, the new investor’s shares worth USD$2.5 million will be divided by the post-money valuation amount of USD$12.5 million (and not by the pre-money valuation of USD$10 million) to get the percentage concerning the total equity ownership.
The cap table is an essential and valuable tool for existing shareholders and would-be investors. It contains details about the equity ownership structure of a business. Investors can look at the estimated post-money valuation to know how much percentage of the company they’ll be owning if they put in their money.