Understanding Early Stage Capitalization Tables
An article we liked from Thought Leaders Hambleton Lord and Christopher Mirabile of Seraf:
Who Owns What - Understanding Early Stage Capitalization Tables [Part I]
Several years ago, I was speaking to a colleague of mine.
He was trying to decide between two great job offers, and was having a difficult time making a final decision. When I asked him questions about work environment, the quality of his co-workers and boss, and the future potential for the companies, he responded that both companies fit what he was looking for.
Next, I started asking about his compensation package. For salary and bonus, the two companies were equivalent. However, when it came to stock, there seemed to be a big difference. One company offered him 25,000 shares that vested over a 3 year period. The other company offered 300,000 shares that vested over 4 years. Because one offer was almost twelve times greater than the other offer, my friend felt he should take the job from the company that was giving him more shares. His decision was a pretty typical response from someone without much financial experience.
So I asked him a simple question. “Do you know how many shares each company has issued?” His face went blank and he shook his head ‘no’. He had no clue what I was talking about. I paused for a minute and then asked my question in a different way. “Do you know how big a slice of the company pie you are getting from Company A vs. Company B?”
Now I could see the wheels turning in his head. “Ahh, I get it”, he replied. “I don’t know the answer to that question, but I will ask each company and get back to you with the answer.” The next day he texted me and told me that the 25,000 share offer was equivalent to a bit more than 1% of the company’s total outstanding shares. The 300,000 share offer was about a half percent of that company’s shares. So even though one offer looked very generous compared to the other, in reality, the smaller share offer represented more than twice the ownership position of the bigger share offer.
I tell this story as one simple example of the importance of actually understanding a company’s Capitalization Table (“cap table”) before transacting in their shares. Shareholders who don’t have a good grasp of this important investment concept are at a significant handicap when it comes to investing. If you don’t know what you own, how can you understand either its value today or its potential value in the future?
Ham and I spend a lot of time thinking about cap tables, making sure we understand what our ownership position will be after we invest in a company. Furthermore, we spend time modeling future cap tables for our investments, helping us understand what happens over time as companies raise additional rounds of financing. Let’s ask Ham for a little more about the basics of this so you can wrap your head around what we consider to be one of the most important concepts of early stage investing.
Note: This article is the second in an ongoing series on valuation and capitalization. To learn more about the financial mechanics of early stage investing, download this free eBook today Angel Investing by the Numbers: Valuation, Capitalization, Portfolio Construction and Startup Economics or purchase our books at Amazon.com.
Ham, to start out, what is a Cap Table? Can you give us a simple definition?
Whenever I hear the term “cap table”, I can’t help but …
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