I thought it might be useful to post up a Cap Table Model that can be used by a pre-funding startup and then a financing can be layered in.  In other words, it shows both pre-money and post-money very clearly.  It is a simple model and NOT perfect, but it will work very well in most situations for you.  Here are things to note:

1.  Cells that are shaded yellow are input cells.  For example, cell E2 is the spot to put in the negotiated pre-money valuation.

2.  The model includes a simple waterfall analysis using both participating and non-participating preferred (see line 35 and then columns S and T).  The larger the preferred stock liquidation preference the larger the impact of participating preferred. Play with the investment numbers (increase them in column I).

3.  The option strike price in cell J1 is arbitrary.  I just set it at about 1/4th of the calculated Series A price.  But you should ask your accountants and lawyers about strike prices and Section 409A of the tax code.

4.  The green box at row 36 just provides a nice double check on post-money valuation calculations.

5.  Columns O and P are important as they show the % of preferred stock ownership compared only to preferred stock outstanding.  This is important as there are often charter or contractual provisions that require a preferred stock only vote.

6.  You really should try to focus on cell formulas.  They are simple, but critical to understanding how the cap table works and how valuable the cap table can be to your understanding of your stock holdings.

So….enjoy the model.  BTW, when I ask a company for its cap table (which I typically do as soon as I am actually interested in digging in further), I expect to get it in Excel (not PDF) and I expect to get it quickly.  If it takes a week to show up in my inbox I assume that the management team was not well prepared to pitch in the first place.

Ask any questions in the comments.  Thanks.

I was giving some advice the other day on how to approach Series B investors in terms of valuation.  Here is the hypo (all $$ amounts changed):

1.  Company X raised its Series A at a pre-money valuation of $5mm and it raised $4mm dollars.

2.  So the post-money valuation after the Series A was $9mm.  And the Series A investors then owned 4/9s of Company X.

3.  The Series A round was taken by $2mm of institutional investors and $2mm of angel investors.

Easy facts, but note that because the Series A round was rather large compared to the pre-money valuation the resulting post-money valuation is substantial.

So now is the time to raise the Series B.  Company X has met its milestones.  It has received necessary approvals to sell its device.  It has built out the team.  It has just started to generate revenue.  The team is energized.  It expects revenue of $1.7 million in the coming year.

What should the pre-money valuation be for the Series B?  First of all, when receiving a pitch from an entrepreneur, I hate it when the slide deck has a bullet that says something like “we are raising our $5mm Series B at a pre-money valuation of $17mm”.  Last time I checked, the pre-money valuation was the #1 most negotiated term in a deal.  And you are now trying just to dictate it in a slide?  That makes no sense to me at all.  You might even be low balling yourself by accident.  I would much rather hear “we are raising our $5mm Series B and our pre-money valuation thinking is reasonable; and the next slide has a simple use of proceeds for the proposed raise.”   Now you have opened yourself up to a normal negotiation if in fact I am interested.

Second, and the real point of this post is that while the management team of Company X certainly wants the Series B to be at a higher pre-money valuation than the post-money valuation of the Series A, that in and of itself is rather irrelevant to the valuation discussion.   The fact that the Series A investors accepted to live with a post-money valuation of $9mm in this hypo does not mean that the pre-money of the Series B should be above that.

For example, in this hypo, Company X expects to do $1.7mm of revenue in the coming year.  Let’s assume that the Series B investors think that is reasonable.  The first question they are likely to ask or research (or both) is “what do companies in this space sell for stated as a multiple of revenue”.  I asked the Company X team this question and the response was “3X range”.  So, the Series B investor might take $1.7mm times 3 and get a number that is obviously less than the Series A post-money.  The gap is real.  And the arguments for the gap are valid.  “I hit every milestone,” says Company X so “how can we not be worth more than the Series A post-money?”   To which the Series B potential lead investor says “hey, your post-money is not my problem – why should I invest at higher revenue multiples than what the industry is seeing?  If I do, then I am taking a huge risk that my return will stink.”  Expect this discussion.

One good answer to this gap is that the Company X team must show the Series B investors that they are investing in the future of Company X (not just the next 12 months revenue) and can still make a great return (say 6X and above).  This is obviously true and works well if Company X does not anticipate needing another round of financing, expects to build the revenue ramp quickly and has good product margins.  But beware of the gap!

Lessons:  don’t try to dictate a pre-money valuation in a slide deck and don’t think that the Series B investors will care about your Series A post-money (and this applies to Series C looking at Series B post-money too…..obviously).  The best route to a high valuation is to get multiple term sheets….again obviously.

We (Cayuga Venture Fund) just signed up a term sheet with a new company (Company X).  No need to disclose the company name or industry for purposes of this post.  Rather I want to briefly comment on the process leading up to the term sheet and next steps.

First, the process:

1.  We first engaged with Company X in mid August. It is now mid December.  So our diligence and exploration process took us 4 months.  That is normal for us.

2.  The diligence involved us learning a great deal about Company X’s industry because we have not done a deal in this space previously.  It involved calls with 4 or 5 parties in the space.  It involved a ton of back and forth with Company X’s CEO.  It involved Company X finding a technology lead during our process.  It involved a lot of work by Company X (and by us).

3.  Critically, during the process, we came to trust the CEO and the team.  The CEO was hyper responsive to requests.  He struck the right balance between “salesman” and “information provider”.  This is not always easy.  I loved the fact that the CEO was the person feeding us the answers.  No delegation.  And they were typically good answers.

4.  Also, during the process, we had to clean up the company’s cap table and make sure that we all agreed on who owned what on a pro forma pre-money basis.  Without having a complete pre-money cap table, it is impossible to calculate a share price.  I use the term “pro forma” as often there are equity issues that need to be resolved prior to the deal closing that are NOT currently reflected in the company’s current cap table (like planned grants to advisors, co-founder true ups, etc.).  Sometimes those issues take extra time to resolve.

5.  We presented our first draft of the term sheet to Company X about a week ago.  I told the CEO that I was presenting a basic Series A term sheet with very normal terms.  I called him prior to delivery to point out a few things to purposely draw his attention to them.  No surprises.

6.  He came back with very few comments after reviewing with legal counsel and some of his others advisors.  Perfect.  Fair all around.  The way it should be.

Now for the next steps.  Here is how I outlined them to the CEO:

1.  Line up the balance of the investors.  We are doing $400K out of $1mm, so we need to get commitments from about $600K of additional investors.

2.  Once the $600K is lined up or mostly lined up then I will ask our fund’s lawyers to draft the deal docs and we will engage IP counsel to do an IP review (high level).   It is important to “turn $$on$$” counsel only after we feel good about the deal closing.

3.  Company X will respond to our “boring” diligence request list items by setting up a file sharing box.   We will then review and get our lawyer’s input on items as necessary.

4.  Get the investment documents all negotiated and close the deal in January.  Hopefully there won’t be much to do on the documents, but there are always issues.

I am writing this all down as I think it is important to understand the process at a granular level.  There are a lot of steps and they take time.

Let me know what questions you have.  And Happy Holidays!