Your company may be likely to need several rounds of capital in equity before it becomes fully self-sufficient or can rely on debt capital to carry the rest of the way. Now’s a good time to think far out in the future and plan ahead for all the additional rounds that you expect. This would also include a stock option that you would anticipate for current employees and future hires as well.

Here are some of the things you want to show in this equity table:

1. You want to start with the earliest investments and work your way on down to the final equity infusions.

2. Going across you want to show the amount invested in the company and then what percentage of the company each would have at that particular point in time.

3. You continue on in similar fashion, but at this point for the next two columns you put in what the final ownership percentage would be. And then in the next column what the valuation would be for those particular shares.

4. Almost done, but there’s another important piece left. In the final column, you want to show the rate of return for each of the equity investments. This would consider how much money was put in, and what the future value would be and how much time elapsed between the two periods.

5. The last column is one of the keys. You want to see how the rates of return measure up for different investors at different time periods. Ideally, what you want to see is that the rates of return are highest for the earlier investors and then taper off some for those who come in in later rounds where there isn’t as much risk as there was in the early investments.

What happens if it doesn’t quite work out that way? That’s a sign then that you need to rethink some of the shares given at a particular round. If a return seems to high relative to some of the other rounds and the relative timing, then that’s a sign that you might not have to give up as much ownership at that particular point in time. However, if it works the other way and the return in the immediate stage looks lower than the return at a later stage, that’s a sign that you might need to increase the ownership percentage given at that particular stage.

The key is to have balance between the risk at the particular stage in the venture and the expected return. It could mean that an angel investor might have a 75% return, a first round investor might have a 50% return and the later stage investor might just have a 30% return.

Note that the options may stand out as an anomaly there, that they should have very high particular rates of return. However, those can be justified because it’s going to be those people in management that are needed to make the returns possible in the first place.

Why go through this now, some of these rounds may be two to five years off in the future? That’s a good question. You want to do it now because you don’t want to do anything in the short-term that could box you in during the longer term. It could work both ways. There’s two risks from the earlier period:

1. The most common risk is that too little is given up and it’s too high of a valuation. And then it becomes harder to support with a future round. Because of the high valuation given early, it may be hard to generate the kind of rates of return that an investor at that stage should be getting over the longer term. Using this long-term view can be one reality check against excessive valuation.

2. The other extreme is that two many shares are given up and there’s a high dilution of the company leaving little room for further dilution with the later rounds.

So do this test, plan out all your future rounds of capital when you’re thinking about raising equity. This can be a good barometer for you to make sure you don’t give away too much or give away too little at this particular stage. You want balance. Something that will provide a fair rate of return to somebody now, but at the same time still give you the flexibility to do what you’re going to need to do with future rounds of equity.

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value