Planning for Exit Scenarios: Cap Tables and Valuation Implications

Planning for Exit Scenarios: Cap Tables and Valuation Implications

When starting a company, it’s important to plan for every scenario, including exit strategies. While many entrepreneurs dream of a lucrative IPO or acquisition, the reality is that most companies never reach those heights. That’s why it’s important to have a clear understanding of your cap table and valuation implications from the very beginning.

What is a Cap Table?

A cap table, short for “capitalization table,” is a spreadsheet of all the stakeholders in a company and the percentage of ownership each holds. This includes founders, investors, employees, and anyone else who has equity in the company.

Having a clear and up-to-date cap table is essential for planning exit scenarios. Without it, you won’t be able to accurately calculate everyone’s share of the proceeds in the event of an exit. This can lead to misunderstandings, disputes, and even lawsuits.

Valuation Implications

When planning your exit scenarios, it’s important to understand how different valuations will impact your cap table. This can get complicated quickly, but here are a few key factors to consider:

Dilution

One of the most significant factors is dilution. Every time you raise money, you’re potentially diluting the existing shareholders. This means their percentage of ownership goes down, even if the overall value of the company goes up.

For example, let’s say your company has 10,000 shares outstanding, and you and your co-founder each own 5,000 shares (50% each). Then you raise $500,000 in funding by issuing 50,000 new shares. Your cap table now looks like this:

  • Founders: 5,000 shares each (40% each)
  • Investors: 50,000 shares (20%)

Notice that the founders’ percentage of ownership went down, even though their actual number of shares stayed the same.

Liquidation Preferences

Another important factor is liquidation preferences. This is a term in the investment agreement that determines how the proceeds from a sale or merger are distributed among shareholders.

For example, let’s say you raise $1 million from an investor with a 2x liquidation preference. This means that if the company sells for less than $2 million, the investor gets their $1 million back before anyone else gets anything. Only after they’ve received their $1 million do the other shareholders start getting a share of the remaining proceeds.

Option Pools

Option pools are another factor to consider. These are shares set aside for future equity compensation, such as stock options for employees. Option pools can dilute the existing shareholders further, so it’s important to factor them into your exit planning.

Exit Scenarios

Now that we’ve covered some of the cap table and valuation implications, let’s look at some potential exit scenarios and how they might play out.

Acquisition

Acquisitions are one of the most common exit scenarios for startups. When a company acquires your startup, they’re basically buying your company and all its assets (including intellectual property, customer relationships, and talent).

In this scenario, you’ll need to negotiate the sale price with the buyer. This is typically a multiple of your company’s revenue, but can also be based on other factors like user numbers or intellectual property.

Once you’ve agreed on a price, the proceeds will be distributed according to your cap table and any liquidation preferences. The buyer may also require certain conditions to be met before the sale can go through, such as a minimum level of revenue or profitability.

IPO

An IPO, or initial public offering, is when a company sells its shares to the public on a stock exchange. This is a much more complex and rigorous exit scenario than an acquisition, and requires a lot more time and resources to prepare for.

If you’re planning an IPO, you’ll need to work with investment bankers, lawyers, and accountants to ensure that your company meets all the regulatory requirements. You’ll also need to create a prospectus that explains your business model, financials, and risks to potential investors.

Once your IPO is complete, your shares will be traded on the stock exchange. This can lead to significant liquidity for your shareholders, but also exposes your company to greater scrutiny and volatility.

Secondary Market

A secondary market is a private market where shares of private companies are bought and sold. This can be a good option if you’re not ready for an IPO or acquisition, but still want to provide liquidity for your shareholders.

Platforms like EquityZen and SharesPost allow accredited investors to buy shares in private companies. This can help you realize some of the value of your shares without going through a full-blown exit scenario.

Conclusion

Planning for exit scenarios is essential for any startup. By understanding your cap table and the valuation implications of your funding rounds, you’ll be better prepared for whatever may come. Whether you’re planning an acquisition, an IPO, or a secondary market sale, having a clear plan in place will help ensure that everyone gets a fair share of the rewards.