When considering a private company investment, it’s important to arm yourself with as much information as possible to make an informed investment decision. In the private secondary market, where financial and business metrics are not as readily available as in the public markets, this becomes even more important. A private company’s capitalization table (aka “cap table”) is one of the key tools investors use to evaluate a private company investment. That’s why EquityZen’s research team does extensive research to build cap tables for all of the companies we offer as investments via our funds. Here, we’ll break down what a cap table is and the key components investors should consider when evaluating a private company investment.
What is a Cap Table?
A cap table is the document that outlines the ownership structure of a private company. It provides a detailed breakdown of who owns how many shares and the different types of securities (i.e. Common shares vs. preferred shares) they hold. In essence, a cap table serves as a snapshot of the company's equity ownership with a few key components:
Common Stock: Represents the ownership interest of the founders, employees, and early investors. It is the most basic form of equity in a company.
Preferred Stock: Often held by venture capitalists and other early-stage investors, preferred stock usually comes with certain privileges, such as a preference in dividend payments or liquidation. These preferences can vastly impact the investment return achieved by shareholders at the time of an exit event.
Convertible Notes: Loans typically issued during the company's early stages, with the intent to convert into equity (usually common stock) at a later funding round.
Stock Options and Warrants: These are equity compensation tools used to attract and retain employees, advisors, and consultants. They give the holder the right to purchase shares at a predetermined price. Once purchased, these options and warrants typically convert to common stock. You can find out more about stock options on our blog.a
SAFEs (Simple Agreement for Future Equity) and KISSes (Keep It Simple Security): These are alternative instruments used in early-stage financing, designed to simplify the investment process.
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For investors, understanding a company's cap table is essential for several reasons:
Ownership Clarity: A cap table helps investors know who owns what and in what proportions.
Valuation Assessment: By examining the cap table, investors can estimate the valuation of the company as of their latest funding round. EquityZen provides this estimate in the offering document for each investment opportunity offered via our funds. This information contextualizes the valuation at which an investor may be buying shares versus where the company was most recently valued by institutional investors.
Typically, secondary shares trade at a discount to the last funding round. More recently, the average company has traded at a 40-50% discount to their last round of primary funding on EquityZen’s platform.
Exit Strategy: Understanding the liquidity preferences of the various share classes on the cap table enables investors to understand what they can expect to receive if the company were to exit via a merger, acquisition, or initial public offering (IPO). You can see how this played out in a real life exit strategy example.
Look for any red flags or unusual structures in the cap table, such as large blocks of preferred stock with excessive liquidation preferences, which can significantly impact your potential returns, especially if you are purchasing common stock.
A cap table doesn’t always tell the whole story of a company. It is also important to remember that debt, whether in the form of venture loans or traditional borrowing, typically doesn't show up in cap tables. However, debt carries a unique position with seniority over equity. When assessing the potential outcomes for an investment and the financial health of a company, this distinction of seniority is pivotal. Debt obligations, such as loans or bonds, hold a priority claim on a company's assets and earnings. In case of liquidation or financial distress, debt holders are the first to be repaid, leaving equity holders with the remaining value.
Therefore, when assessing exit opportunities through cap tables, it is important to note that a comprehensive understanding of a company's capital structure is not fully explained in a cap table. For many investors, this is a matter of a “known unknown,” and something to consider when evaluating if an investment is suitable for their risk appetite. Investors should keep debt and liquidation preferences in mind when evaluating their expected returns from a particular investment.
Understanding Dilution: Over time, as a company secures more funding rounds, additional shares are issued, which can dilute existing shareholders. The cap table helps investors understand how dilution may affect their investment by breaking down the share count at each funding round.
At EquityZen, we want to make investing in the private markets as transparent and accessible as possible for our investors. That’s why a breakdown of a company’s cap table is a core part of our offering documents.
While private companies don’t provide the same depth of reporting as public companies, cap tables provide a view into their potential worth, ownership structure and key liquidity preferences. Furthermore, the potential for asymetrically skewed returns and diversification draws investors to the private markets, especially as companies stay private longer.
Interested in exploring cap tables for the currently available investment opportunities on EquityZen’s platform? Check out our investments page.
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Disclaimer: An investment through EquityZen's platform will involve risks not associated with other investment alternatives. Prospective investors should carefully consider, among other factors, the risk factors.
