Capital Structure Projection for Angel Investors and Entrepreneurs
For the purposes of this section, the term 'capital structure' is simplified to include only shares. Later in a company's lifecycle, the capital structure may also involve various forms of debt.
Capital Structure and Share Register
All jurisdictions have a legal requirements for the 'share register' to list all of the current shareholders of a company. This post provides an example of how to create a share register.
Capital Structure Projection is Necessary for a Meaningful Financial Projection
To build a meaningful financial projection for a company, and to predict the future value of the shares of the company, you need a projected capital structure (i.e. projected share register). The capital structure projection shows the effects of future financings on the number of shares outstanding, and the percentage ownership for the founders and investors.
Its important for company founders and investors to agree on the projected capital structure as a confirmation that the entrepreneurs and investors are aligned and effectively communicating about future financings and the exit strategy for company. It is surprising how often the investors and founders have not in actual fact communicated clearly on these critical alignment questions.
A Projected Capital Structure is Psychologically Healthier
Another benefit of working with a capital structure projection is that is is psychologically healthier for founders to understand the realities of dilution and percentage of the company they will own after the third or fourth financing, rather than the percentage they own at startup. Most of the time, founders will fix the percentage of the company they owned at startup in their mind without factoring in the inevitable dilution from future rounds of financing. This often leads to a negative psychological reaction to issuing new shares to raise equity financing - regardless of whether it is accretive.
If you have not lived through the realities of dilution before, the easiest way to understand it is to spend some time working with a projected capital structure that incorporates a company's future financial requirements. The example share register available here includes several rounds of equity financing, typical of a successful angel backed company.
The projected capital structure is one of the first impressions an investor receives when starting due diligence on a company. If the projected capital structure is complete, logically laid out and effectively formatted, prospective investors will feel like the company is organized, compliant and managed by entrepreneurs who understand how future rounds of financing will affect their company and their shareholdings.