Knowledge Base: Cap table maths & dilution: The impact of different funding rounds, discounting & options pool

This guide includes the following, jump to needed section:

• Understanding cap table maths & funding round dilution
• Why create new shares instead of selling existing ones?
• The relationship between pre-money valuation, share price, and dilution
• Cap table maths: Worked examples
• Cap table scenarios: Same round vs Agile vs New round
  • Scenario 1: Two investors in the same funding round
  • Scenario 2: Initial followed by an Agile Round
  • Scenario 3: Initial followed by a New Round
• Discounting investors
• The impact of an options pool
• FAQs

Understanding cap table maths & funding round dilution

A cap table, short for capitalisation table, is a record of ownership stakes in a company. It's crucial to understand how ownership changes during funding rounds due to share dilution.

When a company raises funds, it issues additional shares rather than selling existing ones. Here’s a simple example to illustrate this:

1. The founder starts with 10 shares and sells 1 to Investor 1. Now there are 11 shares, so Investor 1 owns 9.09%.
2. The founder sells another share to Investor 2. Now there are 12 shares. Investor 1's ownership dilutes to 8.33%.

Even though Investor 1 and Investor 2 are part of the same funding round, Investor 1's ownership percentage decreases because more shares have been issued. The founder’s ownership also dilutes due to the increased number of shares.

Misunderstanding the math behind a cap table can lead to confusion. Here are two common mistakes:

1. Shares sold vs. ownership percentage: You might think that if your company has 100,000 shares in circulation and you sell 10,000 shares, the investor owns 10% of the company. In reality, they own 9.09%. To give them 10%, you would need to issue 11,111 shares, as 11,111 divided by (11,111 + 100,000) equals approximately 10%.

2. Pre-money valuation and investor ownership: If your pre-money valuation is £1.5 million and you sell £150,000 worth of equity, your investor will not own 10% but 9.09%. To give them 10%, set the pre-money valuation to £1.35 million because £150,000 divided by (£1.35 million + £150,000) equals 10%.

There are some worked examples included in this guide to bring this to life.

This calculator is helpful when calculating pre and post money valuations.

You can also add dummy investors to the platform to model the impact of adding new investors. Make sure you don't send the invitation emails until you are happy with the ownership structure. You will see video walkthroughs of this further down this guide.

If you want to model the impact of multiple rounds on founders / investors we have a handy excel model (screenshot below):

Click the links below to see the impact of:

• Same round vs Agile round vs New round
• Discounting
• Options

Why create new shares instead of selling existing ones?

In almost all cases, you should issue (or "allot") new shares to your investors rather than selling your existing shares. Here’s why:

1. Tax Implications:

   • Selling your shares could trigger Stamp Duty charges.
   • If you sell shares for more than you paid, you may also incur Capital Gains Tax (CGT).

2. SEIS/EIS Requirements:

   • Under the SEIS/EIS legislation, investors must receive newly issued shares to qualify for these tax reliefs. They cannot purchase shares from an existing shareholder.

3. Funding for the Company:

   • If investors purchase your shares, the payment goes directly to you (the current shareholder) rather than the company. However, investors typically expect their money to be used to grow the business.

Due to these factors, SEIS/EIS investments are always structured through the issuance of new shares. Additionally, venture capital investors (VCs) will insist on new shares to ensure their funds directly benefit the company.

The relationship between pre-money valuation, share price, and dilution

When structuring funding rounds, understanding how pre-money valuation, share price, and dilution interrelate is crucial. Investors typically expect a 15% dilution per round, and it's important to account for this when negotiating with investors.

• Pre-money vs post-money valuation: Talking in pre-money terms avoids confusion, as it clearly defines the value of the company before the new investment is factored in. By mastering these concepts, you'll be well-equipped to manage your cap table, issue shares effectively, and navigate funding rounds with confidence.

Cap table maths: Worked examples

This section covers three basic scenarios of how ownership changes in a funding round.

Scenario

• Pre-money valuation: £1,500,000
• Number of Shares: 10,000
• Share Price: £150 (£1,500,000 PMV / 10,000 shares)

Single Investor; total £100,000

• Investor 1 Investment: £100,000
• Shares Purchased: £100,000 / £150 = 666.667 (rounded down to 666)
• Investment Amount: £99,900
• Total Ownership: 6.24%
  

Two Investors; total £100,000

• Investment: Two investors each invest £50,000
• Ownership Percentages:
  • Investor 1: 3.12%
  • Investor 2: 3.12%
• Combined Ownership: 6.24%
  

Two Investors; total £150,000

• Investors:
  • Investor 1 invests £100,000
  • Investor 2 invests £50,000
    Ownership Percentages:
  • Single investor (Investor 1, £100k): 6.24% (666/10,666)
  • Two investors (Investor 1 & 2, £100k): 6.24% (666/10,666)
  • Two investors investing £150,000 (Investor 1, £100k): 6.06% (666/10,999)

Note: In the third scenario, Investor 1's £100,000 is not worth 6.24%; it's worth 6.06% because there are more investors in the same funding round, resulting in more shares being created.

Cap table scenarios: Same round vs Agile vs New round

This guide walks through various cap table scenarios, including the impact of different funding rounds and shareholder actions like introducing new investors, applying discounts, or creating an options pool. These examples help illustrate ownership percentages and dilution effects.

Scenario Setup

• Shares: 10,000
• Pre-money valuation (PMV): £1,500,000
• Investor 1: £100,000
• Investor 2: £50,000

This table summarises the impact of multiple (two in this case) investors in the same round, an initial round and then an agile round and then an initial round, followed by a new round.

You can see that the dilution is the same in the initial round as the initial and the agile.

Jump to section to delve deeper into each scenario:

• Scenario 1
• Scenario 2
• Scenario 3

Scenario 1: Two investors in the same funding round

• Investor 1 invests £100,000, and Investor 2 invests £50,000.

Investor 1's £100,000 is worth 6.06%

Scenario 2: Initial followed by an Agile Round

Agile rounds behave the same to adding investors in the initial funding round.

As you can see, if you add agile onto a funding round, it's the same as adding investors to the initial round.

• Founder 1: 90.92%
• Investor 1: 6.06%
• Investor 2: 3.03%

Investor 2 in an agile funding round will be able to see the deal done in the initial round. The investors must review the shareholders' agreement from the previous round, as this is the document they adhere to.

In an agile funding round, you set a minimum share price which is authorised by your investors. It’s important to set this share price low enough to account for any discounts you intend to offer. Common practice is to base the floor on the highest share price from the previous round, which protects investors from shares offered at a lower price than theirs. While you can adjust the share price during an agile round, it must always remain above the established floor.

Scenario 3: Initial followed by a New Round

Once you've closed the initial round you can start a new funding round. In this example, we've added Investor 2 for £50,000. You see that this investment changes the ownership percentages as new shares are issued:

Pre-new funding round:

• Shares: 10,666 (10,000 + 666 from initial funding round)
• PMV: £1,500,000
• Share Price: £140.63

As you can see, the dilution if different. The £50,000 investment 3.22% so investor 2 benefits from coming in a later round (investor 2 in the other scenarios has 3.03% ownership). This means the founder and investor 1 dilute more - see the summary table below;

Discounting investors

In practice, the best way to give investors a discount is to increase the PMV to what the other (non-discount) investors will pay and then apply the discount for the investor.

You change the PMV in 'Step 1: Defining'

You add investors and discount specific investors in 'Step 2: Inviting'

If we continue from the scenario above;

• Shares: 10,666
• PMV: £1,500,000
• Share Price: £140.63
• Share Price at 50% discount: £70.32
• Investor 1 shares purchased: £100,000 / £140.63 = 711 shares
• Investor 2 (50% discount) shares purchased: £50,000 / £70.32 = 711 shares

See a walkthrough on how to input a discount here:

Note: The term sheets for each funding round will detail every investment clearly, as investors will want to understand the cap table both before and after their involvement and the impact on dilution. Investors are likely to request similar discounts after seeing previous deals. You will need to provide a justification to investors as to why they are receiving different share prices.

Note: When inviting investors to participate in a funding round, they will sign an NDA, an FCA disclaimer, and a term sheet. If you later adjust the discount, the signed term sheet will still reflect the initial investment and share allocation.

We simulate real-world transactions by not issuing revised term sheets for every change. Constant updates would require investors to sign numerous versions of their term sheets as the round evolves. In practice, this approach has no legal implications since the term sheet is non-binding and is ultimately replaced by the Subscription & Shareholders Agreement and the Articles.

The impact of an options pool

Creating an employee share option scheme, such as an Enterprise Management Incentive (EMI) or an Unapproved Share Option Plan, is a highly effective way to incentivise employees. Here are some key considerations:

1. Not registered at Companies House:

• Share option plans, including EMI and Unapproved options, are not listed on public company records.

2. Timing and size: It’s generally in a founder's interest to:

• Delay setting up the option scheme for as long as practical.
• Keep the pool size modest (10%-15% is a common range).
• Avoid creating an oversized pool:

If, for example, you allocate a 50% share option pool but only utilise 10%, the remaining 40% will dilute the ownership of all shareholders, including those investors who may not have been directly affected by the initial dilution.

• To create an options pool for future use, go to the cap table section in your platform.
• Learn more in this

By understanding these scenarios, you can better navigate funding rounds, manage dilution, and strategically align with investor expectations.

FAQs

Can potential investors looking through the data room, before they invest, see other potential investors?

Yes, each investor appears in the CapTable and the investment documents.

Captable - it is very standard for CapTables to be open (not least because details are published openly on Companies House anyway). If investors want to be secret then they should use an SPV.

Documents - the draft documents contain the names of other potential investors, specifically the Term Sheet and Subscription and Shareholders agreements list all current and proposed investors in a round

Would the lead investor dilute when opening the round to wider investors to fill the remainder of this round or would it be just myself that dilutes?

Everyone dilutes when you issue new shares. You can potentially issues non-diluting shares, but:

• These aren’t compatible with SEIS/EIS at all.
• These will be a very major turn-off for future investors.
• They are VERY unusual indeed.

What's the difference between authorised shares and total number of shares in circulation?

• Authorised shares are the number you can create. This doesn’t mean much, as you can authorise more.
• Shares in circulation are the number of shares as of today

How small an increment can a share be? 0.00010 seems really small?

This is the nominal value - the typical range for nominal values can be from £0.000001 to £1 per share but there is no set requirement in the Companies Act.

You can increase shares using an SH02 - see this Article