After a year of bi-weekly blog posting I just want to say thank you to those of you who have read my articles, shared them, liked them, and given me amazing feedback. I truly could not have done this without you. In this post I want to focus on WHAT happens when you raise money and how that affects ownership structure in your company. This structure is captured on something called a capitalization table. Let's take a look at the basics of the capitalization table and how it changes as you raise money.
What is a Capitalization Table? How Does it Change?
A capitalization (cap) table shows the equity ownership breakdown for a company. It typically shows the number of shares and an ownership percentage breakdown. As additional capital gets raised, new shares get issued and those new investors get added to the cap table. The ownership percentages get adjusted based on the new share totals and in the case of a liquidity event, that is the percentage of money each member of the cap table walks away with.
Let's take a look at an example. Imagine you (Person A) and a co-founder (Person B) start a business and issue 1M shares at $1 per share. With 1M shares at $1 per share, your company is now valued at $1M. Your cap table will look like the below:
Now imagine you go to raise money from an investor (Person C). They agree to give you $1M at $5M valuation post-money. Since the additional capital is $1M and the post-money valuation is $5M that means the pre-money valuation is $4M. Since there are currently 1M shares in the company, the value of those shares now jumps to $4 per share. At $4 per share price Person C gets 250,000 shares since they put in $1M and the cap table now looks as follows:
Person C now owns 250,000 shares out of a total 1,250,000 so they have a 20% ownership stake in the company (exactly equal to $1M in a $5M post-valuation company). Person A and B now own 500,000 shares each out of the 1,250,000 so their stakes drop to 40%. However their shares are now worth $4 per share so they sell they get $2M for their shares as opposed to $500K their shares were worth before Person C put the money in.
It's important to remember the price per share only changes BETWEEN rounds and NOT WITHIN a round. The share price was still $4 per share at a $4M pre-money valuation and $5M post-money valuation after the $1M was invested. The share price only jumped when the $1M post-money valuation from the previous round jumped to a $4M pre-money valuation in the next round.
Finally, let's imagine there was a liquidity event and the company sold for $10M. Each person in the cap table would walk away with their equity share percentage in the cap table. In this case, Person C would get $2M (20% of the $10M) and Person A and B would get $4M each (40% of the $10M).
Summary
The cap table tracks all of the equity ownership in a company at any given time. As money comes in, more shares are issued and more people get added to the cap table. In a liquidity event, each person on the cap table gets paid out based on their equity percentage. Remember the share price only increases between rounds, previous post-money to new pre-money, not within a round. If you are having trouble calculating and organizing your cap table, reach out to us at InfleXion Point. We are happy to help!
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