Last week, we hosted a workshop session for junior VCs focused on cap tables. The session was led by Theo Wethered (Principal at Nauta) and Iulia Tudor (Partner at Ascension) and is the first in a series called Fundamentals, which I’ve been working on alongside my good friend Freya Wordsworth (Associate at Ascension).

What is Fundamentals?

Fundamentals is a series of educational sessions created by junior VCs, for junior VCs. We’re fortunate at both Nauta and Ascension to receive great training, but even with that training, a lot of learning is expected to happen on the job.

As there is no ‘VC manual’, we wanted to create the resources we wish we had to learn from! We hope this can make us better equipped to make the investment process as smooth as possible for startups we work with.

Cap tables is a broad topic and so, in the first session, we covered the importance of managing the cap table over time, why PPS is so important, the 'dilution effect' and how to model ESOP creation and converting CLNs.  

If in doubt, price per share (PPS) is your north star

If you read no further, this is your main takeaway. While valuations typically grab the headlines, PPS is the true metric of value creation. Even though it seems like an arbitrary number (and a company’s initial PPS is basically made up). Investors buy and sell shares, and how PPS changes tell you literally what each share is 'worth' in £/€/$ terms.

Ultimately, exit proceeds are divided out on a per share basis. More importantly though, most of the mistakes you can make in modelling investments can often be avoided by first calculating PPS and going from there.

PPS of a round vs the PPS of the last round is therefore the true measure of the 'upround', not just the headline valuation. An example scenario is depicted below where, for example, something that might sound like a decent (40%) valuation uplift (£20m pre-money of last round to a £28M pre-money at the next round), may in fact be a flat round on a PPS basis.

Should the ESOP be structured pre- or post-round?

An Employee Share Option Plan (ESOP) is a tax efficient way to give employees an equity incentive in the performance of a company. It must be structured correctly and verified with HMRC (or respective tax authority) for compliance. From choosing an EMI qualified strike price at Series A, to allocating it fairly and topping it up to the right level at each round, every decision can impact dilution and future deal terms.

It’s important for both founders and investors to be clear on how ESOP will impact the round. How large should the ESOP pool be? And will it be created pre-round or post-round?  

We explored examples of creating an ESOP pool pre-round and post-round and were reassured that "it’s ok to spend 20 minutes doing basic algebra to calculate the number of ESOP shares that must be created to give a certain targeted level post-investment". We also discussed how the timing of the ESOP top-up can impact the PPS.

Modelling a Convertible Loan Note (CLN)

Convertible Loan Notes (CLNs) - including SAFEs and ASAs - can be a good option when startups need capital and it's beneficial to delay formally valuing the company (e.g. a bridge round). Whilst they are simpler to set up, versus a priced round, figuring out how they convert can be more complicated!
 
For CLNs, there are some important things to remember:

• Converting CLNs contribute to dilution: When considering an investment, always remember to factor in CLNs that will convert with the round to understand the overall level of dilution.

• Check the legals: As Iulia emphasised, it is important to always be clear on the exact terms of the CLN, including qualifying conversion events and what defines the conversion price, laid out in the legals.  

• Don’t forget accrued interest: CLNs are a loan that will convert to equity. Don’t forget to include accrued interest in the value of the CLN.

• Discount the pre-money, subtract the outstanding balance of the CLN (inc. interest): When calculating the conversion price, it’s tempting to apply the discount to the new round's pre-money valuation, but don’t forget to subtract the outstanding balance of the CLN (including accrued interest) from the discounted pre-money. That’s where most of the mistakes come from! If this number is below the valuation cap of the CLN, this is the price the CLN converts at.

Putting all of this into practice

While generic cap table templates can be a helpful starting point, we discussed the importance of getting comfortable with the formulas so that you can apply them to any cap table. Real-world companies can have many stakeholders, each with unique terms.  

One useful approach is to build a 'formula driven' spreadsheet with shares split by stakeholder (e.g. each founder, investor, employee) and by class (e.g. ordinary, preferred). This level of detail allows you to see how the cap table has evolved over time, understand the dynamics of the proposed investment round and model future scenarios (e.g. subsequent round or exits).  

If you have any questions about cap tables and the materials referenced here, please contact me (ana.fernandez@nautacapital.com), Theo (theo.wethered@nautacapital.com) or Freya (freya@ascension.vc). Equally, if you would like to attend a future Fundamentals event or have requests for topics we should cover, we’d love to hear from you.