Avila Ahmed posted an update 5 months ago
A VC Cap Table (cap table) is generated by venture capital firms and their legal departments to give an overview of the individual and corporate ownership in a venture or start-up company. In that post, we provided an explanation of how a venture capital firm determines the value of a company based on its business model, technology, market size and other factors. Specifically, we explained that valuation is determined by using future earnings (EBIT), free cash flow (FCF) and other metrics. In this post, we’ll continue discussing what a VC Cap Table represents. Specifically, we’ll discuss why venture capital firms use one, and how they determine an enterprise’s value based on these types of tables.
First, let’s discuss what a cap table is. A cap table is a hypothetical representation of all of the different ways the value of a given company can change between the time it becomes public and the time the company goes public. VCs use cap table math to estimate the potential value of a business based on publicly available information and future capital contributions by the company’s founder(s).
The reason a VC uses cap tables is because the process of valuing a company is very complex. To begin, remember that vcs do not typically provide investment advice. Instead, startups provide financing information and a method of computing the value of a company using sophisticated financial models and historical data.
Thus, understanding how to interpret a cap table involves both understanding how VCs make investments and understanding the effect of certain funding events on a business’s intrinsic value. Most importantly, it is important to recognize that a VC does not make purchases in a traditional manner. Rather, a VC provides capital funding to an organization by purchasing shares from the owners of the company. Alternatively, a VC may provide seed money or stock in a start-up company. The purpose of these transactions is to provide seed money for entrepreneurs or to purchase companies at an attractive price from an angel investor. Once a venture goes public, the venture is then purchased by an entity or group of entities (usually referred to as “clients”) whom the VC has agreed to invest in.
As previously mentioned, a cap table describes the value of a business that is based on a number of financial assumptions. One such assumption is the price per share of the stock (or “priced share” in VC terminology). In general, most venture capitalists base their investments on an analysis of three factors: the price per share, the book value of the company’s equity, and the weighted average assets and liabilities per share. However, due to the fact that the companies they invest in may have varied ownership structures, the weights each of these factors should be maintained in varying degrees. One way to do this is to create multiple-period composite Cap Tables that use the same weights for all the assumptions used in the comparisons between the periods.
Another advantage to creating a post-money cap table is that it makes the comparison of shares in a start-up to that of a well-established publicly traded corporation easier. The method of calculating a start-up’s per-share price is to use the discounted cash flow method; for a well-established publicly traded company, it’s more convenient to use the present day value of the net worth of the equity instead of using the original purchase price. In addition, some VC investors use the coupon note purchase and sale method of determining the value of a business’s shares. Either way, it’s almost impossible to compare two different companies based on their pricing structure if those pricing structures are not identical. A post-money cap table helps make this comparison easier because of the different ways it’s calculated.
Perhaps one of the most common types of cap tables used by private investors is the dilution principle. This principle states that for any given stock, there is a dilution effect, which means that a typical dilution (i.e., 10% of the stock being issued) will lower the market price of that stock by one percent. Most private investors use the diluted stock method (dilution) because they believe that founders should be rewarded for their risk, but they don’t want dilution to affect future equity holders.
Regardless of startups of cap table management arrangement or the value of the dividend included in the price of a company’s stock, there are significant advantages to paying a monthly or annual fee to a professional management company. By using an experienced vc finance provider, entrepreneurs can reduce their risk, improve their efficiency and increase their overall profitability. Additionally, these companies can make adjustments to the company’s ownership structure at any time without waiting for approval from the founder.