Options Trading and Cap Table Math
What is a cap table? It is a standard tool for companies to use in order to assess the skills and interests of potential employees. Each company has a unique group of minority and majority interests represented on its cap table. On the face of it, a cap table looks like just a series of easy math problems. Over time, you begin to realize that cap tables really are driven less by pure cold hard facts and more by emotional and social soft power. That's where I think the problem starts.
Let me explain what I mean. A company's cap table typically contains stock options and warrants valued in the pink sheets. At the end of the financial year, or each stock's valuation at the end of its second anniversary, the CEO usually presents the company's cap table to stockholders for their approval. The shareholders will typically approve the cap table by voting on the matter via the company's Board of Directors. This is a critical function because it determines the price the stock will be priced at. In essence, the CEO votes on how much he wants to make from the stock option exercise.
The key piece of cap table math is the use of the discount rate and the dividends received model. These models are designed to calculate the value of the company's ownership structure as a whole. In essence, they are taking the total number of shares outstanding and dividing it by the current market price per share. They then multiply this number by the number of shares you have already purchased. It's a simple process, but when dealing with sensitive numbers, it takes a bit of practice to understand the formulaic that is used.
There are many ways to apply the formulaic pricing to post-money valuation caps and warrants, as well as convertible notes, and all the other derivatives associated with company ownership structures. You have to keep track of not just the price per share but also all the other ratios that are used in the calculation. You have to calculate the numerators, denominators and multipliers, among others. One thing to remember is that there is no one standardized formula for calculating post-money valuation caps or pre-money cap values since each deal is unique.
Here's a good example of using a cap table calculator to determine the value of a private placement. This type of calculator can be found online at various investment banks or financial institutions that specialize in these types of calculations. Many online investment banks will provide a free 30-day sample cap table that you can download from their website. You can then take the information you find and customize your own spreadsheet that contains the same data and formula used in the online demo.
Post-money valuation calculations on options will also depend upon the underlying assets that the underwriters are trying to sell. There are two components to this equation. The first component is what the value of the option is, which is either the strike price or the option price. The second component is called the implied cost of the option. startups is a function of the risk that the buyer is willing to assume in the event that the underlying shares lose value. The formula for this equation is actually much more complicated than the ones used for options on stocks and bonds, since it takes into account the stock's performance as well as the volatility of the market and the overall economic condition of the company.
Calculating liquidation preference using cap tables is actually quite difficult. The formulas that you use will depend upon whether you are dealing with preferred or common shares. Preferred shares are valued using the depreciated value of the shares, while common shares are generally much simpler to calculate using the present value of the company's cash flows. Determining startups of the shares using these formulas will require the help of an investment professional.
One of the benefits of using a cap table is that it can provide an investor with a rough idea of the value of their shares at any point in time. The option pool can also be used by investors who own shares that are not publicly traded. Using the numbers provided by these formulas, they can determine when it would be a good time to sell their shares in the open market.