Cap table dilution math - Valuations in share prices

This is the 3rd part of the Pro Cap Table training course. In this series we go through the basics you need to know, then worksheet by sheet so you know how to make a seriously kick-ass cap table.

The focus is on explaining pre and post-money valuation and then the importance of understanding how these translate into a price per share.

Introduction

In the last edition, we explained how dilution works at a high level, step by step.

Now we need to explain how valuations work and how they can be expressed in terms of share prices. This can be a little confusing, but thinking in terms of share prices is a level-up you need to do.

If you’re a dab hand at cap tables already, then you can skip this and head to the next edition.

If you’re not a boss at cap tables, then don’t skip this. You need to know how cap table dilution math works in detail.

This is 101 math and you absolutely need to know it all by heart. It gets harder from here and if you don’t know how this works you are going to struggle.

Pre-money and post-money valuations

I know learning this stuff is boring, so here is an image I tested DALL-E to try to generate a formula for post-money valuation. It’s clearly terrible, lol! Heck, I have to amuse myself whilst I write all this for you!

Understanding Pre-Money and Post-Money Valuations

Venture capital investors talk in terms of pre-money and post-money valuations. You have to understand the difference.

I recommend not trying to understand the logic of the ‘valuation’ etc. You won’t. Just learn the formula and remember for a founder that pre = bad and for an investor, post = good.

Investment

• Definition: The dosh investors wire you to ride your ass in board meetings.
• Significance: Determines whether TechCrunch writes about you and how impressed other nerds are at parties.

Pre-Money Valuation

• Definition: The valuation of your company before any new investment is added.
• Significance: Determines how much your company is worth before you receive any new funds from investors.

Post-Money Valuation

• Definition: The company’s valuation after adding the new investment.
• Formula: Pre-Money Valuation + Investment.
• Significance: Reflects the total value of the company after the investment round, crucial for calculating the percentage of ownership given to new investors.

 

Try to internalize that:

• Post is the sum of pre + investment.
• If an investor wants to put anything into the pre, that is bad. You want things to happen in the post (as a founder).

 

To get into more detail, I have written blogs on both Pre-money valuation and post-money valuation.

Basic math on pre/post valuation

Let’s pretend you are doing a little seed deal. How does the math work? Let’s do some numbers now.

You agree with investors that the pre is $4m and you are raising $1m in total. So your post is.. $5m! Boom, shaka laka!

Now, you aren’t raising the $1m from just one investor: you are taking $750k from one and 250k from another.

• Pre-Money Valuation: $4 million.
• Total Investment: $1 million ($750k + $250k).
• Post-Money Valuation: $4 million (Pre-Money) + $1 million (Investment) = $5 million.

 

Stop, do the math on how much the investors own now. Do you know? If not, go back to the last episode in this course.

Calculating Share Prices and Ownership

So now to share price thingies. You can deal with things high-level with pre/post valuations generally, but once you get into cap tables, you will end up noticing there are share prices involved. This is why I’m introducing them to you so you are prepared.

You agree on a price per share implicitly when you agree to a pre-valuation. This determines how much the investor will pay for their shares. You have shares before you raise money, right? Let’s assume that you have 8m shares already.

The px per share is the pre-money valuation divided by the number of pre-money shares

Why do share prices matter?

When you get into cap tables, you will end up expressing investors’ and staff’s ownership in terms of their share prices.

In short, you want the price per share to keep increasing.

1. Investors: If the price per share at the next round is lower than what they own, they are not going to be happy and certain ‘control terms’ could kick in (which are bad).
2. Staff: They get rich if the price per share gets larger.

I might write a blog on why share prices matter. Let’s see.

Share Price Calculation

You have now agreed that the price per share of your company is valued at 50 cents.

• Formula: Pre-Money Valuation / Number of Pre-Money Shares.
• In our example, if you have 8 million shares already, the price per share is $4 million / 8 million shares = $0.50 per share.

Determining Shares Issued to Investors

How many shares do investors get for their money?

You divide the investment of the investors by the share price valuation we just calculated. This is, therefore:

• Formula: Investment Amount / Share Price.
• Investor 1: $750k / $0.50 = 1.5 million shares.
• Investor 2: $250k / $0.50 = 500k shares.

Total Post-Money Shares

So what, they have shares? Most people like to know what % they own right?

Take the shares we just calculated and divide by the total number of shares.

The total number of shares are:

• Calculation: Existing Shares + New Shares Issued.
• In our example: 8 million (Existing)
  • + 1.5 million (Investor 1)
  • + 500k (Investor 2)
  • = 10 million shares.

Ownership Percentage

The total dilution from the seed round is 20%. All the previous shareholders were just diluted by 20%.

• Formula: Investor Shares / Total Post-Money Shares.
• Investor 1: 1.5 million / 10 million = 15%.
• Investor 2: 500k / 10 million = 5%.

Closing

In the above scenario, original shareholders are diluted by 20% (15% + 5% ownership of new investors). They now collectively own 80% of the company post-investment.

There’s a lot more to doing math with share prices but this is a quick guide not an MBA course. And frankly, I couldn’t think of what I need to explain as I’m updating this guide, lol, and have 12 more posts to ship some improvements before I go to bed! ha.

Summary of key terms

Here is a handy summary of all the key formulas that you need to know:

• Post-money valuation = Pre-money valuation + investment
• Price per share = Pre-money valuation / pre-money shares
• Post-money shares = Post-money valuation/ price per share
• Investor ownership = Investor shares / post-money shares

 

There we go. Let’s get moving to the next episode.

Read next step

14 parts in this guide

You can jump to a section if you prefer:

1. What is a cap table and other important questions
2. Cap table dilution step-by-step example
3. Cap table dilution math
4. Starting the cap table (The drop-down menus we need)
5. Shareholders sheet
6. Deal calculations
7. The cap table sheet
8. The assumptions sheet
9. Individual shareholder returns sheet
10. Returns waterfall calculation
11. The ESOP sheet
12. The Common sheet
13. The convertible notes and warrants sheet
14. The preference shares sheets (From Series A to I)