How do you handle equity dilution in a cap table?
Although the dilution impact on company valuation is positive, not all shareholders feel this way. To minimize this, they may want to exercise their anti-dilution rights, i.e., get more shares issued from the company.
To help your investors decide whether to exercise anti-dilution rights, you must provide effective summaries of cap table dilution.
In this article, we will explore how to calculate equity dilution and show this through cap tables, and then, we will end the chapter by seeing examples of cap table visualizations. Read on to know more!
How to calculate equity dilution?
You can calculate at a company level using the following formula.
Let us understand this formula through an example. Suppose a company with 100,000 outstanding shares enters a funding round planning to issue another 50,000 shares.
Then, expected equity dilution percentage = ((50,000) ÷ (50,000+ 100,000)) × 100
= (50,000÷ 150,000) × 100
= (1 ÷ 3) × 100
= 33.33%
So, we can see that 33.33% is expected on a company level.
However, this figure may not be useful for all stakeholders. Investors with anti-dilution rights would want to know when they exercise and when they do not exercise their rights.
Equity dilution through cap table
Some of the ways in which you could show equity dilution through cap tables are:
Pre- and Post-Money Cap Tables
In funding rounds, it is common practice to share pre and post-money cap tables with all key stakeholders. In both versions of the cap table, shareholders can see the number of shares they own, the value of their stake, and their percentage stake.
By observing the change in ownership stake percentage, stakeholders can understand the dilution impact.
Waterfall Chart
A waterfall chart is a type of column chart that visually tracks the cumulative effect of sequential changes to a variable, starting from an initial value. The first bar represents the starting point, and subsequent bars illustrate positive or negative changes.
This stepwise structure makes it easy to see how individual factors contribute to the overall change in the variable, offering a clear, intuitive way to represent complex data, such as revenue breakdowns or equity dilution.
If your shareholders want to understand their stake over a certain period, waterfall charts could be a good way to assist them.
Scenario Analysis
If you are heading into a funding round and you are unsure how many shares you will be issuing, which shareholders will exercise their rights, and to what extent, you could share an analysis of various scenarios.
As part of this analysis, you will need to prepare cap tables for each scenario. Then, for each stakeholder, you will need to prepare a matrix where the column headers are different numbers of shares issued and the row headers are anti-dilution rights exercised and rights not exercised. In each cell of this matrix table, you will need to fill in the appropriate ownership percentage of the stakeholder.
On Eqvista’s cap table management software, we provide a scenario analysis feature where all you need to do is enter the necessary inputs.
How to calculate equity dilution at an investor level?
In this section, through three examples, we will see what the above mentioned ways to present cap table dilution actually look like in real life.
Example 1 – Pre- and post-money cap table
NexaCore Engineering is planning to raise $3 million from its Series A funding round by issuing 10,000 shares. Currently, it has 100,000 outstanding shares. If NexaCor Engineering is successful, its post-money valuation will be $33 million.
NexaCore Engineering had two investors in the seed round, one of whom will exit by selling his stake to the incoming investor. In the seed round, both investors were issued 5,000 shares. Let us look at NexaCore’s pre- and post-money cap table.
| Equity holder | Pre-money | Post-money | ||||
|---|---|---|---|---|---|---|
| Number of units | Value of stake | Percentage ownership | Number of units | Value of stake | Percentage ownership | |
| Founder | 90,000 | $27,000,000 | 90% | 90,000 | $27,000,000 | 81.82% |
| Investor A | 5,000 | $1,500,000 | 5% | 5,000 | $1,500,000 | 4.55% |
| Investor B | 5,000 | $1,500,000 | 5% | - | - | 0% |
| Incoming investor | - | - | 0% | 15,000 | $4,500,000 | 13.64% |
| Total | 100,000 | $30,000,000 | 100% | 110,000 | $33,000,000 | 100% |
Through the pre- and post-money cap table, all stakeholders can see the dilution impact.
Example 2 – Waterfall analysis
Matt Affleck invested in Green Cell, a sustainable battery startup, at the seed funding stage. Of the 30,000 shares issued, he received 20,000 and the company’s total outstanding shares increased to 120,000. In the Series A round, Green Cell issued another 30,000 shares and Matt bought another 5,000 shares from other investors.
Then, at the Series B stage, of the 30,000 shares issued, Matt received 10,000. Matt made a complete exit at the Series C stage.
This information can be summarized as follows.
| Particulars | Entry (Seed) | Series A | Series B | Series C (Exit) |
|---|---|---|---|---|
| Shares owned at the start of the year | - | 20,000 | 25,000 | 35,000 |
| Shares bought from other investors | - | 5,000 | - | - |
| Shares issued to the investor by the company | 20,000 | - | 10,000 | - |
| Shares sold to the company | - | - | - | 35,000 |
| New shares issued by the company | 30,000 | 30,000 | 30,000 | 30,000 |
| Total outstanding shares | 130,000 | 160,000 | 190,000 | 220,000 |
While this is a very comprehensive table, if Matt only wants to review the effects over the funding rounds, it lacks utility. He will need to calculate the ownership stakes at each funding round. Then, he will need to calculate the changes in the percentage ownership stake.
Instead, if Matt generates a waterfall chart on Eqvista’s cap table management software, he will get the following visualization.
This is a much neater presentation that shows exactly what Matt is looking for, the cap table dilution over funding rounds.
Example 3 – Scenario analysis
MiniShield, a cyber security company, is planning to issue 20,000 shares in its Series A funding round. Currently, it has two external investors, Margot Murdock and Bill Kelly, with 10,000 shares each. If these investors exercise their rights, another 5,000 shares will be issued to them.
For instance, if Margot exercises her right, she will have 15,000 shares and MiniShield will have to issue 25,000 new shares. If Margot and Bill exercise their anti-dilution right, they will receive 5,000 shares each and MiniShield will have to issue 30,000 new shares.
So, the four scenarios that could unfold are as follows:
Based on this information, let us create a percentage stake matrix for Bill to help him understand the impact in all these scenarios. Here, Bill’s percentage stake is his shares divided by the total outstanding shares in each scenario.
| Particulars | Margot Murdock | ||
|---|---|---|---|
| Anti-dilution rights exercised | Anti-dilution rights not exercised. | ||
| Bill Kelly | Anti-dilution rights exercised | 11.54% | 12.00% |
| Anti-dilution rights not exercised | 8.00% | 8.33% | |
Eqvista: Crystal Clear Cap Tables, Confident Dilution Management
On a company level, dilution is calculated as the number of new shares issued divided by the new total outstanding shares. However, this may not be valuable for all investors as some may have anti-dilution rights.
Hence, it is better to use visualizations like pre- and post-money cap tables, waterfall charts, and scenario analysis to provide investors with better clarity regarding cap table dilution. You can choose between these visualizations depending on the needs and access level of the shareholder in question.
All of these cap table dilution visualizations are available on Eqvista’s cap table management software. We also offer features like 409A valuations and support for board resolutions. Contact us to know more!
