TL;DR: Excel isn’t just for modeling economics; you can also use it to quickly find critical information about which investors are entitled to which rights. In the case of participation rights in a future equity financing, create a separate table to keep track of how much of the next round your current investors are entitled to.
Download the open-source cap table and the example spreadsheet.
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Congratulations, your Series A has closed without a hitch! You were able to save time and money by modeling out the broad contours of the round yourself, and you saved much heartache down the road by having your experienced startup lawyer iron out the details, negotiate the definitive documents, and manage the overall process for you.
After you file your Form D with the SEC and put out a glowing news release about your burgeoning blockchain-based frozen banana delivery/infotainment empire, you start to get cold LinkedIn DMs from bigger VCs interested in leading your next round. You recall that some of your Series A investors have “Major Investor” status by virtue of their share ownership, which means, among other things, that they have the right to participate in the next round. But how do you know for sure who is a Major Investor, and how much of the next round do they have the right to buy?
As your trusty startup lawyer has told you, participation rights likely won’t be as simple as multiplying the Major Investors’ current ownership percentages by the proposed round size, or allowing them to buy enough to maintain their pre-round ownership percentages. The terms of participation rights (also called, in each case potentially misleadingly, preemptive rights or pro rata rights) are usually negotiated in an Investors’ Rights Agreement (IRA), or a Stock Investment Agreement if you used the so-called Series Seed documents as a starting point. This section will assume that you’ve entered into an Investors’ Rights Agreement based on the NVCA form favored by professional investors in startups.
Who is a Major Investor?
There are two main ways to determine which investors qualify as Major Investors, other than contractual provisions explicitly granting a particular investor Major Investor rights. The first is by stating a minimum qualifying number of “Registrable Securities,” which means the number of shares of common stock (including common stock issuable on conversion of preferred stock) that need to be held by “Investors” – i.e., the money, not the founders and employees, even if they’ve put money in (assuming they don’t also hold preferred stock). As an example, Major Investors might be those holding at least 500,000 shares of Registrable Securities. In that case, assuming preferred stock converts to common on a 1-to-1 basis and the investors hold only preferred stock, you’d just look to the number of preferred shares held by each investor, no matter what series, to see whether it exceeds 500,000.
It can become more complicated when the Major Investor threshold is framed in terms of a dollar amount, for example, the purchase of at least $300,000 worth of Registrable Securities. This is because VC rounds often include multiple series of preferred stock at different “original issue prices.” As discussed in the prior two sections, preferred shares issued on conversion of SAFEs and convertible notes usually have a different original issue price from the new-money preferred shares because of the valuation cap or the discount. The original issue price drives the liquidation preference. If you sell preferred stock at $1.00 per share to new investors but your SAFEs convert at $0.50 per share, each SAFE conversion share should have a liquidation preference of $0.50, not $1. You’ll often find multiple subseries of preferred stock to reflect SAFEs and notes with different caps or discounts. Startup lawyers often call the issue that this fixes “liquidation overhang” and the subseries of conversion shares “shadow preferred.”
Thus, if you have two or more types of preferred stock outstanding, in order to figure out who spent enough on your preferred stock to qualify for Major Investor status, you’ll need to use multiple original issue prices to calculate it. The example spreadsheet shows how to do this. You add another small table to the bottom of your post-financing cap table that includes each original issue price and the Major Investor dollar threshold. Then add a new column to the cap table to test each investor. For each subseries of preferred stock, multiply the number of shares held by the investor by the original issue price, sum the total for each investor, and compare that to the threshold. A sample formula construction might be SUM( [Series A-1 OIP] * [# of Series A-1 Shares], [Series A-2 OIP] * [# of Series A-2 Shares]) >= [Major Investor Threshold]. The operator >= (testing whether the left quantity is greater than or equal to the right quantity) returns TRUE or FALSE in answer to the question of whether an investor qualifies as a Major Investor.
To make the Major Investor column easy to read, I will often use conditional formatting to highlight a TRUE result in green. To do this, select all cells in the column, go to the Home ribbon > Conditional Formatting > Highlight Cells Rules > Equal To > TRUE with green text and fill. This is particularly helpful with a large number of investors.
Lawyer note: Be careful with rounded numbers. As you saw when modeling a Series A financing, if an investor wants to invest a certain dollar amount, that doesn’t mean that investor’s wire transfer should be exactly that dollar amount. Series A per-share prices are rounded, often to four or five decimal places. Because all shares must be fully paid, if an investor wants to invest $300,000 in a round priced at $2.5333 per share, the actual amount invested will be $299,998.45. So if the Major Investor threshold is set at $300,000.00, this investor will not qualify. If the intent of the parties is to give the investor Major Investor rights, either the investor will need to bump up the investment amount by the price of an extra share or the threshold will need to be lowered to $300,000.00 minus the price of one share. This is a common misunderstanding, particularly for rounds with multiple closings, that your trusty startup lawyer can help you avoid.
Calculating participation rights
Now that you know who the Series A Major Investors are, how do you determine how much they are entitled to purchase in a Series B? The usual language in the Investors’ Rights Agreement (under the heading “Rights to Future Stock Issuances” or similar) can be a bit opaque, but usually it means some variation of, “A Major Investor can invest up to its pro rata share of the next round, where ‘pro rata share’ means the number of common stock equivalents held by the Major Investor divided by the fully diluted capitalization of the issuer.” Fully diluted capitalization for this purpose usually means all common stock outstanding, assuming all options and warrants are exercised and all preferred stock converts to common. Another formulation suggested by the NVCA form provides the Major Investors the right to take the whole new offering for themselves, split up proportionally among them by ownership (i.e., a true preemptive right). Many variations are possible, so as with all of this, be sure to consult with your trusty startup lawyer before telling your investors what you think they’re entitled to.
For purposes of illustration in the sample spreadsheet, we’ll assume that the IRA provides for a pro rata investment right based on the number of common stock equivalents held by a major investor divided by the fully diluted capitalization of the issuer, excluding the unused option pool. To calculate the investment rights in this case, create a separate table below the cap table and simply multiply the proposed round size by that ratio for each Major Investor. You can expand this to a full Series B model to include share numbers as well if you’d like – follow the same steps as with the Series A model.
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