Capitalization – An How to Investors Calculate It
Capitalization refers to the value of the outstanding shares. As such, the calculation of outstanding shares is relevant to determining the percentage of ownership. As mentioned a separate lecture, the number of outstanding shares may be calculated as:
- issued shares only;
- issued and outstanding shares that include all options, warrants, and convertible instruments that could convert into common shares (the “fully diluted” measure); or
- authorized shares taking into consideration the possible options, warrants, and conversions; but, also estimating a certain number of forfeiture of shares and buy-backs by the company.
Ownership percentage is calculated based upon common shares. Each measure will affect the ownership percentage of a holder of common shares. The calculation gets a bit more complicated when calculating in whether options to purchase for shares have vested or no. Non-vested shares are still subject to forfeiture. Calculating the fully-diluted shares thus makes assumptions about the vesting (and forfeiture) of shares.
Any investment calculation will be represented in a capitalization table “Cap Table” that lays out the outstanding shares and those to be awarded in the transaction. The Cap Table will indicate the category of equity ownerships (common shares, preferred shares, warrants, options, convertible debt). The Cap Table will also account for the pool of shares typically set aside for use as compensation for managers of the firm. Option pools are discussed in a separate lecture. Below is an example of a Cap Table.