What Are the Basics of Pricing a Business on the Pro Forma Cap Table?
A pro forma cap table is a financial spreadsheet which depicts the capitation structure of an enterprise today and/or immediately after a successful investment (i.e. on a pro forma basis) by the owner. It depicts the actual value of shares, founders and shareholders, fully diluted, immediately after a capital funding round and separates common and preferred shareholders among many other things. These sheets are used in determining the value of shares as offered for an IPO offering. They are a critical tool to investors when determining if they are being appropriately valued for future consideration.
Cap tables are calculated based on current market values of the company's shares, less any required up-front cash outlay (if a capital financing transaction is required). They can also be calculated with adjustments for original issue price and original debt or equity. Investors must be wary of the potential for these adjustments to yield inaccurate conclusions. For instance, if the original cost of shares or debt is much less than the market price after an IPO offering, an investor may conclude that the shares have undervalued the enterprise.
However, if the price per share has actually dropped to a lower price than the enterprise's shares after the offering, then the investor would believe that the enterprise's shares have undervalued the shares. startups of the shares will be different from what would be expected if the price per share of the organization is equal to the per share of its book value (based on the purchase price). startups to offset this problem is to determine the exact value of the enterprise's shares using the pro forma cap table. The formula for this calculation involves the enterprise's total assets divided by its total liabilities, plus net worth, less cash and stockholders' equity.
Another option investors have to deal with the pro forma cap table is to use the discounted cash flow method. This is not really a type of cap table, but rather an alternative to standard cap tables. The discounted cash flow method actually takes into consideration the time value of money and discounting it to present to investors. By doing this, the actual return on investment can be considerably reduced. Investors may view this as a lower risk/reward scenario and as a way to potentially earn a higher return on their investment.
One other alternative investors have to deal with the pro forma cap tables is to use a financing round. A financing round is used when a company needs additional capital to finance acquisition of certain assets or to finance growth in order to avoid short term liquidity crunch. Investors who are unfamiliar with financing rounds may want to do research in this area prior to making an investment. There are a variety of sources from which this type of funding can be attained and the best way to determine how it would work for your business is to speak with someone knowledgeable about finance.
The pro-forma cap table allows investors to calculate potential return on investment by determining the net present value of all the future streams of dividends that will be received. If these payments are made at regular intervals then it is called a regular dividend. On the other hand, if they are made only quarterly then it would be known as an annual dividend. Dividends are one of the most important factors used to determine the fair market value of the stock. This is calculated by taking the current stock price and multiplying it by the current market price per share times the dividend rate. The result is the fair market value of the company's common stock.
An additional alternative investors have to deal with the pro forma cap table is to use the post-money valuation method. Investors need to remember that there are two forms of valuation; fundamental. Fundamental valuations are based on how the business is performing as compared to the overall market. Fundamental analysis will always take more time because the market is more volatile than the non-fundamental methods. Since the valuation of companies in the pre-money and post-money markets do not match up very closely it is very difficult to correctly predict what the value of the company's stock will be immediately prior to its issuance.
One of the main reasons why many investors choose not to use the pro forma cap table when pricing their businesses is because they believe the process of pricing is too complicated and that it could take too long. However, startups are the ones that run the risk of losing too much money if they do not do their homework and compare different companies before deciding which one to purchase. It is important to realize that when you purchase shares in a business you are buying a gamble. The value of the business can change dramatically in a matter of minutes. You may find out that you bought at a very cheap price and sell it for much more later on when the price has drastically increased.