Module Description:
In this session, Sunil Nagaraj explains how startup cap tables work. He starts with a blank Excel sheet and builds up a new startup's capitalization table ("cap table"). It begins with 2 co-founders with an initial option pool, then we model in a pre-seed
Full Transcript:
Hello, everyone. Welcome to our Ubiquity University session on Cap Table 101. Ubiquity Ventures is a pre-seed and seed stage venture capital firm investing in software beyond the screen. That means we back entrepreneurs who are taking software off the computer, off of the phone, into the real physical world, usually using smart hardware machine learning. In today's session on Cap Table 101, we're gonna start from scratch and build up a basic cap table for a new startup. Cap table meaning the tool that is used to show the ownership of a startup by founders and investors. So at that, we'll dig right in.
So let's start here and let's make a new company today. We'll call the company NewCo. I won't be too creative about it. And with NewCo, we'll have two owners. In particular we'll say that there's Jim and Pam. And Jim and Pam are co-founders. They've known each other for a while, but they choose to split the equity in the company, not 50/50, but 40/60. So upon recommendation from their lawyers, they actually don't do four and six shares. They do four million and six million shares. So, we'll go ahead and put that in for now, four million and six million shares. Another thing they do that's fairly common is to go ahead and get ahead of things they go ahead and create an option pool. And what this is, is a way to go ahead and account for the fact that they will hire more employees. And they can go ahead and carve this chunk of shares out for future employees. So they'll go ahead and do that, and for now they'll put, let's say, a million shares in this option pool. Now these are waiting to be allocated, but we can include them when we talk about a total number of shares. So, the total number of shares in the company is 11 million. And what we can do is compute. These are called common shares. We'll talk more about later what the difference is. And then we can talk about a percent of common and go ahead and do the math here of what percent each one represents. So as we do this, you'll see that, although Jim and Pam split the company 40/60, Jim now has 36% because of that option pool.
So at this point, in most companies, you know, you work for a little while, build some product, get some customers, and then one day when you go out to raise capital, you may get a term sheet, and this might be a pre-seed round of $2 million at six million pre-money valuation. And there's usually a stipulation around the option pool. So I would say six million pre-money valuation inclusive of a 20% post-closing. A little bit wordy, but all of those words actually matter. Post-closing on allocated pool. So this is the round that these folks end up signing up here. And what that means, let's lay this out little by little with inputs, the pre-money valuation will be six million. One, two, three, one, two, three. And what we'll do, like in any good model, is we'll make that blue. Then the new capital in this round will be composed of two investors. Let's say investor A and then investor B. And investor A will do $1 million, or let's say one and a half million dollars. And then investor B can do $500,000. So now we have the total amount raised in this round, which is total new capital. And then we can show, for convenience, the post-money valuation. The post money valuation is the pre-money valuation plus the new money. So, again, that would be six plus two. At this point, we can compute. Let's see here. Actually let's just list again the post-closing pool target is at 20%. And again, we'll make that blue here for a second. For a minute we'll just put... What we'll do, yeah, let's go ahead and continue modeling then. Let's model in this round in the cap table. So, there's gonna be a pool increase. As you can see, we're already only at 9% in the pool, so we'll have to increase. So we'll just put a placeholder for now. We'll figure out the math in a minute. Pool increase, and let's put in a number for now. Let's say another one million. I think we don't think that's correct, but it'll just be a placeholder for us. So, this can be the total number of shares, and then we'll model in the pre-seed preferred shares. So, to do these pre-seed preferred shares, what we'll wanna do then is figure out when investor A puts in one and a half million dollars, how many shares does that purchase? Well, we need to know the price per share. So let's put that down at the bottom here. Pre-seed PPS, price per share. And the way to think about that, this term sheet said $6 million values the company before the round, but it has to include the option pool increase. So what we could do is say $6 million divided by the number of shares in the company. But we know that's not the whole story, because we have to add the option pool increase. So we'll go ahead and include that. So what we have with this math here is $6 million divided by the total share count prior to the shares, the new preferred shares being created. So when we do that, we get a price per share of 50 cents. Again, this is a very important formula in any term sheet, which is how you compute the price per share. $6 million divided by the original amount of shares, plus the option pool increase, which is fairly standard in price financings. Now that we're at this point, then we can start to add in investor A and investor B. So investor A is putting in one and a half million dollars, and they're buying at 50 cents a share. So, they will have three million shares and then we can drag that down, and now investor B here is $500,000 buying 50 shares, buying at 50 cents a share.
So, that's a total of four million shares. We can go ahead and add percent of preferred here, which will tell us that investor A here is buying three outta the four million shares of preferred. And then we can do a total column, and then we'll do percent of total. Sometimes this is called fully diluted, 'cause it includes all of the options, even if they haven't been issued. That's sort of the definition of fully diluted. So, the total shares will be common, plus any pool increase. The pool is future common shares. And then plus preferred. And we can take that, drag it all the way down, bring over our sum here. So this is how many shares are in the company and then we can bring over the percentages. Now we're almost done with our cap table. Again, we had common shares when Jim and Pam set it up. They added an option pool preemptively, just because their lawyer said it was a good idea, which it is. They can figure out the percent of common. The company sat like this for a while while it was growing. They decided to sign this term sheet of two million at two million pre, including a 20% pool. We modeled in a placeholder. We're gonna have to come back and fix that.
And then these are the number of shares that are purchased, and the number of shares purchased is based on how much money you put in using a certain price per share, which is a very important figure here. Then we can figure out the percent to preferred. Turns out this is useful later on. We'll cover that in diving into financial documents for the financing. But knowing the percent of preferred turns out to be really important and that can see the total number of shares. So when all is said and done, Pam, who started with 60% when it was just Jim and Pam, it was 55% after the option pool, is gonna have 38% at the end of this financing. So, she was diluted by her proactive decision to accept financing. So 38% of the company is what she owns. Now let's do one last thing, which is to fix that final number. 'Cause what we can see here is post-closing, that is after this round, there's only 13% of the pool. That's the wrong number. So first we're gonna go into the Excel settings to just double check that we have iterative calculation turned on. This allows us to do, in a sense, kind of circular math. And we will go ahead and save this as well. So what we want to happen is we want that 13% there, over here, to be 20%. So I'll go ahead and put in 20% here. And then instead of this one summing from the left, I'm actually gonna have it multiply from the right. That 20% times the total number of shares. So now we have this correct, right? This column is correct, but what is incorrect is this sum. These two numbers do not equal 3.5 million. So the final piece is we'll subtract to make sure that our pool increase is exactly the right amount, and hopefully this works accurately. So now what we've done is we said the pool was at one million before, which was arbitrarily 9% of the company before the financing. By adding this very special amount here, I'm gonna turn off the yellow, this pool increase number, which we iteratively calculated in Excel, we now end up with the number of shares that when added to the total is 20%. So it's a little bit circular, but what you end up now is the exact ownership after this financing, which if you notice, that pool increase actually lowered the price per share. So Pam, instead of owning, I think it was 37%, now owns 33% of the company for accepting this financing.
And once we have this model, it's a pretty flexible model. Let's pretend that instead they don't raise at six million pre. Instead they raise at seven million pre. One, two, three, one, two, three. Then you'll see that instead of owning 22%, Jim owns 23%. So they get to hold on more, hold onto more of the company. The price per share is a little bit higher. Similarly, if they have a smaller post-closing option pool target, 15%, then Jim has 24% instead of 22%. So there's these variables here that'll kind of be interactive here, but in many ways they all just inform the price per share. So the price per share, that's why I say it's such an important number. So, this is our introductory cap table. The basics of how it works with common, pool, preferred and modeling in a basic price financing.
So this is our session on Cap Table 101 from Ubiquity Ventures. We'd love to hear from you and set up a meeting if you're interested and have a interesting startup that fits with the software beyond the screen idea. Please reach out. We're at pitch.ubiquity.vc, and I personally would love to hear from you if you have any questions or thoughts on this module. I'm at sunil at ubiquity.vc. Thank you.