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Original article

The Best Way to Do Cap Table Math (In My Opinion…)

Key takeaway

• For entrepreneurs: Understanding cap table math is crucial for accurately calculating ownership and avoiding costly mistakes in equity negotiations.
• For investors: A thorough grasp of cap table calculations ensures fair valuation and prevents unintended dilution during funding rounds.

Summary

Dave Lishego presents a comprehensive method for calculating cap tables in complex financing scenarios involving equity rounds, convertible notes, and option pool refreshes. He argues against using simplified shortcuts, which can lead to errors, and instead proposes a shares-based approach. This method, while requiring more algebra, provides clearer logic and more accurate results, especially when dealing with multiple variables like convertible notes and option pools.

Insights

• Simplified "shortcut" methods for cap table calculations often lead to incorrect results due to faulty assumptions.
• The "effective pre-money method" is a common but potentially misleading approach to cap table math.
• Framing the problem in terms of shares rather than dollars provides a more accurate and less error-prone calculation method.
• The recommended method uses the formula: Post-Money Shares = Pre-Money Shares + Equity Investor Shares + Noteholder Shares + New Options.
• This approach can be easily adapted for different scenarios by adding or removing terms as needed.
• Understanding the underlying logic of cap table calculations is more important than memorizing formulas.

Implications

• Entrepreneurs and investors need to be more cautious when using simplified cap table calculation methods.
• More time may be required to perform accurate cap table calculations, but this investment can prevent significant errors in ownership allocation.
• Improved accuracy in cap table math can lead to fairer negotiations and valuations during funding rounds.
• A better understanding of cap table mechanics can help founders make more informed decisions about equity distribution and financing options.