The Capitalization Table provides investors with a bird’s eye view of the sum total of all the different securities issued by a company. It includes the amount of investment that the company has procured from investors and the distribution of securities which might include common/preferred shares, options, warranties etc. and the individual capitalization ratios.
The driving force behind an investment in a company is its expected return on investment, which should be profitable as well as lucrative. For investors, the tool used to state expected return is called a capitalization table, which is used in tandem with pro forma financials. Thus, the usage and preparation of capitalization tables is of great interest to prospective investors.
Basically, a capitalization table addresses the present and future funding requirements of the company as well as returns in terms of value that will be obtained over a period of time. It implies that the investor is greatly concerned about whether the returns on investment are good enough to justify the risk involved or not. The capitalization table encapsulates all the details about the amount of equity capital used in funding the company, the time of capital contribution and the ownership of the company. This information helps investors better understand their returns on investment.
Terms most commonly used in capitalization tables are “pre-money valuation” and “post-money valuation”. The former refers to the company’s value prior to any investments made by an investor. When the pre-money valuation is divided by fully diluted shares outstanding, a price per share is obtained. The latter refers to pre-money valuation plus whatever amount is invested. Obtaining the exact picture regarding calculation of pre-money valuation is not so much a scientific endeavor as it is an art form. There is great scope for personal judgment. All said and done, pre-money valuation is, by its very nature, negotiable.
However, getting future valuation for the exit can be achieved more scientifically.
There are a number of formulas that help determine the value of the company but, often, just one solitary equation without need for other and more complex formulae will help solve the issue. For a company wishing to achieve higher valuations at exit, it must have first achieved a sustainable competitive edge, and normally this may only occur after six years or more for those companies having planned for a five year plan of action. That makes it imperative for companies to outperform “also ran” companies and prove to the competition that trying to imitate more successful companies will surely not be of much use.
Some important and noteworthy aspects that a capitalization table should address are:
• Notes and other forms of corporate ownership
Building a capitalization table is of vital importance and knowing how to build one is essential for any entrepreneur wishing to deal with shares of stock. In addition, there is a need to understand the different circumstances under which it operates. Every interested entrepreneur should learn the arithmetic behind each deal to prosper in his or her business dealings. Also, asking questions of investors to understand their needs is important to an entrepreneur dealing with investment options.
A capitalization table may be segmented to show the differentiation between preferred and common shareholders. In addition, it describes the different funding rounds in the company. Thus, it follows that the capitalization table is an instrument that needs careful analysis before arriving at an informed decision about valuing a company.
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Wade Anderson is a CPA and operates DigitalWorkTools.com
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