Why You Need To Understand Your Waterfall! (pt. 1)

waterfall analysis

Understanding how proceeds are distributed amongst your shareholders and employees is critical in assessing both equity deals and exit. Many founders only focus on their captable and lose track of the waterfall implications.

Captable is a widely used term in Venture Capital meaning a table showing the capital structure / who owns stock in a company. Usually this means an excel sheet with all holders of shares, their number and percentage ownership in the company. After a few venture capital rounds, founders leaving and employee stock option plans (ESOP) it gets messy fast.

The captable does not reflect how the proceeds are distributed in case of an exit. With investors having preference rights, liquidation preferences and implemented employee plans the table does not show how much € everyone might expect when the company is sold.

This is where the waterfall comes in, it shows how proceeds are distributed in case of an exit. A simple case could look like this:

i) Proceeds (could be cash or shares or a combination) plus cash in the bank at time of exit.

ii) Minus all debt

iii) Minus Cash and Exit Bonuses

iv) Minus Preference shares, participating preferred portion

v) Minus Preference shares pro rata

vi) Minus Common shareholders pro rata

= 0

Based on your shareholder agreements, ESOP plans and conditions from the buyer this could look a thousand different ways and in many cases is not very straight forward. Having this clear will help you select the right investor terms and help you align your stakeholders in case of an exit.

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