The Critical Cap Table Mistake I Made
Years ago, one of the first things I did as a new part-time CFO for a startup was put together a financial model projecting their operations and financials for the next five years. A key component of this involved putting together a capitalization table showing how the ownership of the company would change after a proposed investment round with new investors was closed. I felt pretty good about the model, the CEO and I worked through edits and changes to reflect how we saw the business growing, and we sent the model to their existing investors to get their input.
That’s when I learned that I was making a critical mistake.
The VC replied back and pointed out an error in my cap table, pointing out an important error in my math. I was computing the new round investment and post-round ownership based on ownership percentages, not shares, and that fundamental misunderstanding of the mechanics behind the round led to some pretty big errors in the projected cap table.
The lesson I learned that day was think in terms of shares, not ownership percentages, because the mechanics behind investment rounds were based on shares and share prices.
A big mistake, fixed. But more were to come.
That was in 2004. Back then it was harder to find explicit details and analysis about how venture fundraising worked: there were far less information publicly available within a couple minutes searching the web. It’s a brand new world today, and there are tons of posts (and opinions) on how startup financials and venture fundraisings work.
But it can still be hard to understand and see how some of the mechanics behind cap tables work. There are tons of examples that cover small parts of cap tables, whether it’s valuation, share issuances, liquidation preferences, option pools, participation rights, or more, but it can be hard to piece it all together. That’s why I built a cap table model (free download here) to help people understand how the mechanics of cap tables work from funding to exit.
The model structure captures a lot — how share prices, share issuances and valuation through multiple rounds of financing impacts the value and ownership of founders and investors, how premoney and postmoney option pools work, how liquidation preferences work (including participating preferred and participation caps), and how to create a waterfall analysis of proceeds to different classes of investors at exit — but there are a couple simplifying assumptions that make it easier to use for 90% of everyone using it. To dig deeper behind the model and understand the mechanics behind cap tables, consult the list of resources and explanations.
My mistakes didn’t end in 2004.
In putting this cap table model together, I had to research a number of topics to make sure I was modeling the mechanics correctly. The math and mechanics behind cap tables isn’t hard, but it’s not necessarily intuitive. I learned that I was calculating pre- and post-money option pools inaccurately. I learned how to model liquidation preferences, I learned exactly how to lay out participating preferred and participation caps. As an ex-VC, I’ve known what the terms are, how they work, and explained the basics to founders in the past, but I always focused on the important parts of investing in startups, rather than the detailed math behind cap tables.
Details matter. Even today, nearly all cap tables are wrong. But hopefully using this spreadsheet model can help provide you with a good starting point and base of knowledge to understand how they work.
