Monday, December 7, 2020

Startup Cap Table 101: Reflecting a New Equity Financing

In the first blog post about cap tables, we talked about setting up equity compensation pools.  In this blog post, let's learn how to add a new equity investment to the cap table.  Let's assume that our startup has 2,000,000 founder shares outstanding, a 500,000 equity compensation pool, and a pre-money valuation of $1 million.  The investor is investing $200,000.

So, the cap table pre-financing looks like this:

                           Type of shares        # of shares        % fully diluted
Founder                Common                1,000,000            
Founder                Common                1,000,000
Pool                      Common                500,000
Total                                                    2,500,000            100%

To get the price per share that the investor will pay, we use the following formula:
pre-money valuation / # of shares outstanding, which in our case will be $1 million / 2.5 million shares = $0.40 per share.

Investor will own 16.7% of the company following its investment.  We get there by using the following formula: Investment amount / post-money valuation = % ownership, which in our case is $200,000 / $1,200,000 = 16.7% (BTW, post-money valuation equals pre-money + the amount of investment).

To find out the number of shares that the investor will get, we need to divide the investment amount by the price per share, which is $200,000 / $0.40 = 500,000 shares.

So, our new post-investment cap table looks like this:

                            Type of shares        # of shares        % fully diluted

Founder                Common                1,000,000            33.3%
Founder                Common                1,000,000            33.3%
Investor                Preferred                500,000               16.7%
Pool                      Common                500,000               16.7%
Total                                                    3,000,000            100%

We can get the same results by using different formulas.  Imagine that, as in the previous example, all you know is the following: (i) number of outstanding shares pre-financing, (ii) the startup pre-money valuation, and (iii) the amount of financing.  

                            Type of shares        # of shares        % fully diluted

Founder                Common                1,000,000            IV
Founder                Common                1,000,000            IV
Investor                Preferred                II                           16.7%
Pool                      Common                500,000               III
Total                                                    I                         100%

Using the known information, we can fill in the missing amounts.  We know that the investor will own 16.7% post financing by dividing $200,000 / $1.2 million post-money valuation.  

Let's solve for I:  We know that III+IV = 83.7%.  We also know that 83.7% equals 2,500,000 shares.  This means that I equals 3,000,000 shares (2,500,000 / 0.837).  

Let's solve for II:  If 100% equals 3,000,000 shares, then 16.7% will equal 500,000 shares.  Therefore, investor will receive 500,000 shares.  

Let's solve for III:  We can calculate III by dividing 500,000 shares by the total 3,000,000 shares.  

Let's solve for IV:  With the pool and investor shares taking 16.7% each, we have 66.6% left, split equally, to the two founders holding 2,000,000 shares.  This gives us 33.3% ownership for each founder.  

Since we know that a $200,000 investment buys 500,000 shares, then the price per share will be $0.40.

Although some numbers may be somewhat off due to rounding errors, the formulas should work.  

Next, time, let's see how to reflect the conversion of convertible notes at the time of the financing.

This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.

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