Analyzing the Capital Structure of a Start-Up

No one wants to invest in a losing prospect. As you gather information and prepare to invite investors into your start-up, a focus on its capital structure will become necessary. Investors will need this information in order to determine the company’s financial health and risk profile, before they decide to invest.

How do you present information on capital structure?

Your capitalization table (cap table) becomes incredibly important at this stage of attracting investors. The balance sheet itemizes your company’s equity and convertible debt financing. Both equity and debt provide a company with resources, but each come with their own pros and cons.

Reviewing your cap table and the proposed value of the company allows investors to determine how much of the capital structure each of these items represent, their ownership percentage if they decide to invest. The company’s cash position and monthly expenses demonstrate the company’s ability to control costs and the length of time it will be able to operate, and helps potential investors to evaluate their own risk tolerance. An investor is interested in more than a good idea.

How do investors view equity?

Investors view equity favorably because it represents shares of ownership in a company that will be sold (hopefully at a large multiple) during an acquisition. The downside for the company is that exchanging equity for capital means that you must relinquish partial ownership of the company, known as dilution.

How do investors view debt?

Debt is simply borrowed capital typically in the form of convertible notes and occasionally secured loans. The advantage to owners is that you retain full ownership rather than exchanging stakes in your company. But of course, all debts must be repaid, and therefore can serve as a liability. Also, investors in the venture capital space avoid debt-laden business as debt is paid off before equity in any acquisition.

What do investors want to see?

The answer can depend upon each investor’s priorities. In general, investors want to assess a start-up’s current and future enterprise value, and predict the future impact of expenses. They seek to evaluate the likelihood of future events and opportunities, such as buyouts, acquisition targets, debt refinancing, or recapitalization.

Varying sources of equity and debts will each carry different effects on the cost of capital, which then influences enterprise value. A solid understanding of capital value informs investors of potential rewards and risks of investing in a particular company, and helps to establish a final price that an investor is willing to pay.

Guidance during this part of the start-up process is essential to effectively demonstrating true enterprise value to investors, and gathering the capital necessary to succeed while protecting your own interests. Contact us if you wish to receive more insight into this process and for assistance in demonstrating your start-up’s worth.

Picture of Michael Kimball, Esq.

Michael Kimball, Esq.

Mike Kimball offers practical, timely, and economical legal solutions that move projects along and allow you to focus more on your core business objectives. He has years of experience partnering with companies ranging from Silicon Valley startups to firms in aerospace, biotech, construction, and many more. Mike’s in-house experience includes Yahoo!, Krux Digital (acquired by Salesforce), and Commerce One. He has worked on transactions with Eurostar, Red Bull, Major League Baseball, NASDAQ, Goldman Sachs, Liveramp, Amazon, and NASCAR.