How Much Is Your Stock Really Worth?
Startup Tip of the Day
One of the most confusing areas for first time founders is managing the capitalization table, often referred to as the “cap table”.
The cap table outlines all equity owners, the percentage of ownership of stock, debt or convertible debt (debt that turns into equity at a given date or upon an event as outlined in the note’s terms), execution dates, ESOP (employee share option pool) and vesting schedules.
The goal of the Cap Table is to provide a clear view of all owners of the startup company, and outline valuation of all shares on a fully diluted basis (meaning after all options have been duly executed).
If you’re falling asleep at this point, just stay with me!
Yes, it can be confusing, but it’s the backbone of both compensation for investors and employees, and also the crystal ball for a prospective investor to determine how a future round of financing plays out. Who wins? Who loses? Under what circumstances do they and the company win?
Why should a Cap Table matter for you?
When you think you own 30% of a startup, after truly running the numbers across all liquidation preference scenarios, acquisition events, and taking into consideration the convertible notes (if any exist), ESOP, and other scenarios, you may in fact own much less, like 15% of the startup once all factors are considered.
For my first startup, I recall using an Excel spreadsheet to keep all equity owners, investors, long term debt and shares accounted for — it was a total pain in the you know what!
Cap Table Tools to the Rescue:
You can see exactly how the cap table adjusts based on if your company is acquired for $5 million, $50 million or $100 million.
Why are Cap Table scenarios secretly important?
Because based on the investor covenants and liquidation preferences that you agree to on the term sheet, even if there is a nice liquidity event (you sold your startup for x dollars), you may in fact never receive the true value of your stock, or in some scenarios, not even a penny of remuneration.
Imagine that, spend 7 years building a startup from idea to exit, get acquired, think you own 20%, start calculating your net worth in your head, and then walk away with nothing.
A cap table played out under different acquisition scenarios will show you exactly how much compensation you’ll have waiting for you. This will become your new target acquisition number, not simply the first offer an acquirer throws your way.
Have an employee that left before their 1 year cliff (a common structure to force employees to stick around in order to claim their vested shares)? Just plug and play and you’ll quickly see how the shares are re-pooled and how that affects everyone’s equity positions.
Talking to a prospective investor and want to run a scenario on their offer to see how that might play out under different circumstances? Just plug the data in, hit enter and voila.
Cap Tables don’t have to stress you out, be intimidating, or suck the life out of your startup’s time. Having a digital cap table will also help you be open to structuring different forms of deals with investors whereby you offer more stock but on different terms, thus putting your startup in the best scenario based on the outcome that you’re aiming for.
Don’t get suckered into taking investor dollars on their terms without fully understanding how all scenarios might play out. As they say, there’s dumb money, and there’s smart money.