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Cap table cheat sheet

This document is designed to accompany the cap table available with The Secret of Raising Money
(www.thesecretofraisingmoney.com)
Copyright © 2014 The Secret of Raising Money (contact@thesecretofraisingmoney.com)

List of topics
1. What is the cap table?
2. What is pre money and post money?
3. What is a discount rate (in the context of convertible debt)?
4. What is a valuation cap?
5. What are options? What is the option pool?
6. I’ve awarded advisory options. Where do they go in my cap table?
7. What is the difference between common stock and preferred stock?
8. How do you agree on valuation?
9. How much should I expect to get diluted each round?
10. What are ‘total shares authorized at incorporation’?
11. What are ‘fully diluted shares outstanding?”
12. Why does my stake getting smaller every round?
13. What is the “effective pre money valuation”?
14. What happens to the interest when debt converts?
15. Won’t my lawyers make a cap table for me?
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1. What is the cap table?

The cap table (short for capitalization table) tells you the percentage ownership and
valuation of each stakeholder’s holding in your company. In short: It tells you who owns
what.
2. What is “pre money” and “post money”?
The ‘pre money valuation’ is a company’s valuation prior to the injection of a financing
round’s new capital, and the ‘post-money valuation’ refers to its valuation after that injection.
Post money valuation = pre-money valuation + the amount of new capital raised.
For example, say a startup raises $1m in equity from VC’s at a $5m pre-money valuation.
The post-money valuation is $6m ($5m+$1m). After the round, the VC’s will own 16.67%
of the company ($1m/$6m).

3. What is a discount rate (in the context of convertible debt)?

The discount rate is a mechanism which compensates investors who come in earlier for the
increased amount of risk they are assuming (the earlier an investor gets into a deal, the riskier
his investment). The discount rate ensures that when the debt turns into equity at the next
financing round, the convertible investor will be offered a lower price than the other
investors in that round.

For example, let’s say you raise $100,000 from Angel 1 in your Seed round as convertible
debt with a 20% discount. This means that when Series A rolls around, and the debt turns
into equity, Angel 1 will receive a 20% discount to the Series A price. So if you raise your
Series A round at $1 / share, Angel 1 will get to buy in at $0.80 per share. Instead of
receiving 100,000 shares for his $100,000 ($100,000/$1), he will receive 125,000 shares
($100,000 / $0.80).

4. What is a valuation cap?

Let’s say Angel 2 invests $100,000 at a 20% discount and a $7m cap. If the pre money
valuation of the next financing round is below $7m, Angel 1 will simply receive a 20%
discount to the price of the financing round, as before. However, if the pre money is above
$7m Angel 1 will get to buy in at a price of $7m. So, for example, if the pre money is $14m,
Angel 1 will receive a 50% discount (on a pre money basis) to the Series A equity investors.
A cap offers dilution protection to an investor. If Angel 1’s debt had a discount and no cap,
and the Series A pre money end up being very high (as in the above example), Angel 1’s
resultant equity stake is not (in his eyes) sufficiently proportionate to the significant risk he
assumed by coming in early. Almost all convertible notes (in Silicon Valley at least) are
capped.
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5. What are options? What is the option pool?

Options are rights to buy shares. They ‘vest’ (become available for purchase) over a specified
period. For example, let’s say you award an employee 20,000 options which vest 25% one
year following the award, and then vest monthly for the next three years (an industry
standard vesting schedule). In your cap table, you will demarcate 20,000 common shares
from your option pool for that employee (although you probably won’t get that specific in
the one we provide with The Secret of Raising Money).
At the end of the employee’s first year, he will be able to purchase 5,000 shares
(20,000*25%). Thereafter, every month, he will be able to purchase an additional c.417
(15,000 / 36 months) shares. He will be able to purchase the shares at the ‘strike price’,
which is set via a valuation of common stock performed by an independent party (a "409A"
valuation).
The “option pool” is the total allocation of options set aside for employee and advisors. It’s
typically around 15-20% of the post money valuation.
6. I’ve awarded advisory options. Where do they go in my cap table?
These options come out of the option pool
7. What is the difference between common stock and preferred stock?
Common stock is the type of stock that founders, employees and advisors receive (the latter
two groups typically receive common stock in the form of options).
Preferred stock is the stock which investors own. There are “senior” to common shares.
That is, in the event of liquidation, preferred shareholders receive available funds before
common shareholders. Preferred shares also have a whole host of rights and protections
attached to them which common shares do not. For example – liquidation preference,
protective provisions and participation rights.
8. How do you agree on your seed valuation?
In almost all cases, there is no science to seed stage valuation. The valuation of your
company simply comes down to how much leverage you have over your investors. The
average pre-money for seed stage tech companies is currently around $5m, and the standard
seed stage dilution (post money) is around 15-25%.
9. How much should I expect to get diluted each round?
Very generally speaking, you should aim to be diluted between 10-25% every round. This is a
ballpark figure and the accurate benchmark will be specific to your round.
10. What are ‘total shares authorized at incorporation’?
When you incorporate your company, you will authorize a certain number of shares. This is
the total number of shares that your company is able to issue (i.e. award to founders,
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employees and advisors). You do not have to issue all the shares that you authorize. In our
cap table, we have assumed that all authorized shares are issued.
11. What are ‘fully diluted shares outstanding?”
This is the total count of shares issued, assuming the conversion of all convertible securities
(e.g. the entire pool of options, warrants, convertible debt etc.)
12. Why does my % ownership keep getting smaller every round?
Every time you raise money, you will issue new shares to sell to your new investors. This
process will “dilute” everyone else in the cap table – i.e. on a % basis, all existing stakes will
decrease (this is not always true, but we will keep it simple for the purposes of this exercise).
However, assuming the new valuation is at a sufficiently large step up to the old valuation,
the valuation of the existing stakes will increase.
13. What is the “effective pre money valuation”?
Let’s say you are a sole founder, and you raise a $1m equity round from a VC at a $3m pre
money valuation. So the post money is $4m, the VC’s own 25% ($1m / $4m) and you own
the remaining 75%.
However, you will need to create an option pool to compensate employees. Given a fixed
post money valuation, this option pool has to come out of either your stake or the VC’s
stake. It almost always will come out of your stake.
Mechanically, this means that you will subtract the value of the option pool from the pre-
money, which gives you the ‘effective’ pre money. This is the valuation that the VC will use
to calculate the price per share of the round.
So, in the example above, let’s assume that the post money option pool is 20%. At a $4m
valuation, this means the option pool is valued at $800,000. Hence your actual (effective)
pre money valuation is not $3m, it’s $2.2m. And you own 55% of the company, not 75%.
A similar mechanic comes into play with convertible debt – let’s say you have raised a note,
and then go out to raise an equity round. When the note converts, it will have to come out
either your stake (via the reduced effective pre-money as above) or out of the VC’s stake (in
which case you would add the value of the convertible onto the post money valuation).
14. What happens to the interest when debt converts?
We have kept it simple in this cap table and not accounted for the interest.But typically,
upon conversion, the amount of interest that has accrued up until the point of conversion
will be added to the note and converted into equity.
15. Won’t my lawyers make a cap table for me?
Yes they will. And it will be in your term sheet from your VC when you raise an equity
round.
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But if you are going to run a startup, it is critical that you can put one of these together
yourself, as well as understand the nuances of effective pre money valuation.

Further questions? They are almost definitely answered in The Secret of Raising Money.
If not, email us on contact@thesecretofraisingmoney.com and we will answer them for you