In This Article
- VC Cap Table Overview
- Updating the Cap Table
- Common Line Items
- Dilution Commentary
- Equity Representation
- Before we continue… Download a VC Cap Table model:
- Additional VC Cap Table Uses
- VC Cap Table Math
- VC Cap Table Update Exercise
- Venture Capital Exits
- Recent VC Exit Activity
- Waterfall Flow of Funds
- Demystifying Term Sheets and Cap Tables
A VC Cap Table (capitalization table) is created by venture capital partners and their legal teams to provide a summary of the investor and employee ownership in a startup or venture-backed business.
Since this article will assume understanding of basic VC terminology, we recommend reading that article before going through this one.
VC Cap Table Overview
To begin, a VC cap table tracks the equity ownership of a company in terms of number and type of shares (as well as series) along with any special terms such as liquidation preferences or protection clauses.
The VC cap table for a start-up can start off quite simple at first, initially including just the founders and/or the first handful of employees. But as the company’s employee base grows and more outside investors join in, it can quickly become more complicated.
For this reason, a cap table must be used and be kept up-to-date to calculate the dilutive impact from each funding round, employee stock options, and issuances of new securities.
Thus, all stakeholders can accurately calculate their share of the proceeds in a potential exit (i.e. liquidation event such as a sale to a strategic or IPO).
Sample Cap Table
While there are cap table software programs available, most cap tables are still tracked in an Excel spreadsheet similar to the one shown above.
Updating the Cap Table
The cap table is updated after each investment round, as designated by the term sheet.
Common Line Items
A few of the key items that change on the cap table after a new funding round include:
- Valuation and price per share
- New investors and/or classes of securities (e.g. Series B Preferred)
- Employee option grants and warrants (either allocated or unallocated)
- Debt that has converted to equity
VC cap tables can also be updated as investors exit the company and/or employees leave the company, however, most changes on the cap table are dilutive, meaning the equity ownership percentage of each entity will decrease as more investors join the company.
As long as the company’s valuation is increasing (known as an “up round”), dilution is acceptable, as shown in the following example:
- Founder owns 100% of a company worth $5M
- The next round values the company at $20M, but the new investors want to own 40%
- The founder’s stake of 60% is now worth $12M despite the dilution (i.e., from 100% down to 60%)
As a general convention, VC cap tables group similar parties together.
For example, a cap table can show the company’s founders and key employees first, followed by venture investors, and then angel or minority investors such as family and friends. A cap table may also rank all stakeholders by ownership percentage, generally from largest to smallest.
On a standard cap table, the individual or firm name is listed in one column, followed by their shares in the second column, and then their ownership percentage will be recorded in the last column. The date of investment can also be included.
A typical cap table shows all shares on a fully diluted basis, which means all shares are accounted for, even if they have not been granted or earned yet.
Case in point is a new employee that shows 5% ownership in options that have been granted on her hire date, even though she will not receive the options until they vest, at 25% per year. Should the employee leave the company, her unvested options are forfeited and do not go with her.
There can also be unallocated options on a cap table, which will be allocated as key employees are hired in the future.
Before we continue… Download a VC Cap Table model:
Use the form below to download a complete cap table example:
Additional VC Cap Table Uses
In addition to showing current equity ownership, a cap table is useful for the following:
- Performing an ownership scenario analysis by existing investors of a contemplated next round of investment at various pre-money valuations
- Conducting due diligence by new investors or potential acquirers
- Building 409A valuations and identifying any unallocated options available for new employee hiring
- Performing an analysis of expected returns and proceeds to various providers of capital based on certain exit valuation assumptions
- Legal ownership and tax compliance
The VC cap table becomes obsolete after the company changes ownership, either via purchase or IPO.
VC Cap Table Math
At its simplest, the equity ownership on a VC cap table should add up to 100%. As events occur, such as new investors are added or debt converts to equity, the number of shares on the cap table must be updated to reflect any changes while still totaling 100%.
VC Cap Table Update Exercise
Let’s look at the calculations required to update the cap table with an example:
- Assume a VC is asking for 10% of a company with an investment of $1 million (valued at $10M)
- The company already has 100,000 outstanding shares (50% held by the founder and 50% held by an angel investor)
Question: How many new shares does the new Series A VC get with the investment?
Their new ownership stake can be calculated as: New Ownership Stake = New Shares / (Old Shares + New Shares)
Solving for their new shares: New Shares = [Ownership Stake / (1 – Ownership Stake)] * Old Shares
Now applying the assumptions:
- New Shares = [.10/(1-.10)] * 100,000
- New Shares = 11,111
Checking the calculation, we can see their shares represent 10% of the new company:
11,111 / (100,000 + 11,111) = 10%
The updated cap table is shown below:
Venture Capital Exits
The law of returns of early-stage venture investments states that for every ten Series A investments, 20% (2) will pay, 40% (4) will break even & 40% (4) will fail.
This means that to meet the VC firm’s investor expectations, those who make money on the investment must make up for those that do not make money (i.e., the winners need to return a multiple of the fund).
Recent VC Exit Activity
After experiencing a COVID-19 related dip in Q2 2020 deal count, Q3 showed signs of improvement. As you can see from the figure below, the deal sizes have trended up pre-COVID despite the drop is deal count.
Q3 Deal Activity (Source: PitchBook)
Moreover, while the vast majority of VCs exit their investments through acquisitions, the dollar amounts of these exits are derived largely from IPOs, and more recently, from acquisitions.
The recent public listings of Snowflake (SNOW), Palantir (PLTR), Asana (ASAN), and Unity (U) all helped contribute towards this massive rebound in exit returns in Q3.
Q3 VC Exits (Source: PitchBook)
So while strategic M&A has historically accounted for the majority of exits and returns, these recent high-profile IPOs of venture-backed unicorns are creating all-time high returns for VCs.
Waterfall Flow of Funds
The waterfall flow of funds shows how the proceeds of a liquidity event, such as an acquisition, flow to everyone on a cap table. Using the example above (VC invests $1 million for a 10% stake in a company whose ownership was previously split 50-50 between the founder and an angel investor), let us allocate the proceeds assuming the company sells for $5M, or roughly half its initial valuation, five years later.
Some additional background information:
- The Series A Preferred shares have a 1x non-participating liquidation preference
- The conversion ratio of preferred to common is assumed to be 1:1
First, the Series A investor must decide to either take their preference (i.e., 1x their initial $1 million investment) or convert to common shares and take their pro-rata share of the proceeds:
- Preference amount = $1 million
- Conversion amount = 10% of $5M or $500K
Clearly, the VC will take their preference for a 1x multiple of invested capital, which means they at least get their money back, however this would be considered a loss on a time valued basis. The founder and the angel investor would each get $2M.
Question: What if the company mentioned above were to sell for $100M?
In this case, the investor would convert to common shares and receive $10M, or 10% of the proceeds, while the founder and angel investor would each get $45M.
Demystifying Term Sheets and Cap Tables
The math can get increasingly complicated the more entities that exist on the cap table. For a deeper dive into cap tables, enroll in Demystifying Term Sheets and Cap Tables Course, where we explore the respective negotiating positions of VCs and entrepreneurs as well as dive into the more sophisticated math associated with venture-backed start-ups.
Sample Cap Table Build from our Course on VC Investments
Included in this two-hour course is not only a comprehensive walk-through of the VC deal process, but several exercises to construct a capitalization tables such as the one shown above. More advanced features such as option pools, convertible debt, multiple investors, and liquidation preferences will be introduced, which will be very applicable to anyone interested in a career in venture capital.