Terms like “warrants, waterfalls and preferences” can be confusing and intimidating when attempting to understand a capitalization table (aka cap table); it is no wonder we are often asked for a simple way to understand them! This article will give a brief overview of why cap tables are important and introduce a simple model to use early in the due diligence process.
Imagine you are the manager of a seed stage investment fund. Your job is to make money for your investors through selecting and managing a portfolio of private investments. You work hard to find good deals, to negotiate the terms, and to shepherd each deal to exit. You do this ten, twenty, thirty or more times in your fund, often looking at dozens of deals before making one investment. So how do you get paid?
When entrepreneurs raise capital through the sale of some type of security, the temptation is to take the money from whoever offers to invest, regardless of the amount of the investment offer. It is common practice to set a minimum investment, perhaps $25,000 or $50,000 and simply turn down amounts smaller than that. But raising capital is hard, time consuming work, and it’s difficult to tell small investors “I’m sorry, your investment is not large enough.” It’s even harder when an investor or an angel group pressures the entrepreneur to let them invest at a level below their minimum.
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