Valuation, cap tables, dilution, and ESOPs

₹10 “We are valued at crore” does not tell you what was sold, which rights were attached, how much the founders retain, or what anyone receives on exit.

Valuation is a price reached under assumptions and terms. A public share price is continuously observed but can still be wrong. A private-company valuation may come from one negotiated transaction involving a small part of the company and a bundle of special rights. Treat the headline as the start of diligence.

Keep four values separate

Book equity is the balance-sheet residual: assets minus liabilities under accounting rules. It may omit much of the value built internally in people, processes, software, reputation, or customer relationships.

Equity value is the value attributed to the owners’ shares. For a listed company, market capitalisation is share price multiplied by shares outstanding.

Enterprise value estimates the value of the operating business available to all capital providers. A common bridge starts with equity value, adds relevant debt and debt-like claims, and subtracts cash not required in operations, with other adjustments as the situation demands. Pair enterprise value with pre-interest measures; pair equity value with post-interest measures. Mixing them creates nonsense with professional formatting.

Transaction value is what a particular buyer and seller agreed for a particular security with particular rights. Private preferred shares, ordinary founder shares, and employee options need not be economically identical.

For a mature cash-generating business, valuation usually traces back to future cash flows or comparisons with similar businesses. Both depend on judgment. Discounted cash flow is sensitive to growth, margin, capital needs, and discount rate. Relative multiples inherit any mispricing and business differences in the comparison set. For an early startup, evidence is thinner, so team, market, traction, alternatives, negotiation, and funding conditions carry more weight.

Pre-money, post-money, and the first dilution

Use fictional Kaveri Systems again. Its founders own 10,00,000 ordinary shares. An investor offers ₹2 crore at an ₹8 crore pre-money valuation.

Post-money valuation = pre-money valuation + new investment New investor ownership = investment ÷ post-money valuation

Without another pool or instrument, post-money value is ₹10 crore and the new investor owns 20%. The implied price is ₹80 per share: ₹8 crore divided by 10,00,000 existing shares. The investor receives 2,50,000 new shares.

simple case

The founders own a smaller fraction. That does not prove they are poorer: 80% of a better-funded, more valuable company can exceed 100% of the prior company. The result depends on what the capital enables and the rights attached.

The option-pool shuffle

Now assume the term sheet also requires an employee option pool equal to 10% of the post-money fully diluted capital, created before the investment. The commercial outcome is founders 70%, pool 10%, investor 20%. To show the mechanics, rounded to whole shares:

The implied price falls to roughly ₹70 per fully diluted pre-money share because the ₹8 crore pre-money valuation now includes the new pool. The investor still pays ₹2 crore for 20%; the pre-closing owners absorb the pool. This is why “₹8 crore pre-money” is incomplete without the fully diluted definition and pool treatment.

Assume a later investor then buys 25% of the company and no pool top-up occurs. Every prior percentage is multiplied by 75%: founders fall from 70% to 52.5%, the first investor from 20% to 15%, the pool from 10% to 7.5%, and the new investor owns 25%. A required pool refresh before that round can create additional dilution. Model it explicitly; do not rely on verbal percentages. Convertible instruments add another layer. Conversion price, valuation cap, discount, accrued interest, maturity, qualified-financing definition, and seniority can change the share count and economics. The exact legal form and permissibility are jurisdiction-specific. Put every outstanding or promised instrument into the fully diluted cap table and have a practising CS and transaction lawyer verify it.

ESOPs: compensation, ownership, and an illiquid promise

An employee stock option is generally a contractual right to acquire shares under stated conditions. It is not salary in the bank, and it is not necessarily a share today. Its value depends on more than the number granted.

An employee should ask for:

• • options granted and the corresponding fully diluted percentage at the grant date;
• • class of underlying share and its rights relative to investor securities;
• • vesting schedule, cliff, performance conditions, and treatment during leave;
• • exercise or strike price, expiry, and post-employment exercise window;
• • what happens on resignation, termination, death, disability, sale, or listing;
• • the latest defensible valuation and how it differs from the last preferred-share price;
• • existing preferences, debt, and dilution scenarios;
• • exercise cost, applicable tax timing, and whether any realistic liquidity route exists.

The company should treat the pool as a real transfer of potential ownership. Define grant authority, documentation, vesting, leaver treatment, share availability, accounting, tax, corporate approvals, and statutory records before making promises. In India, obtain current CA, CS, and legal advice for the entity, recipient, plan, and event. Do not copy a foreign template and assume the same result.

Preferences decide who gets paid first

Suppose Kaveri’s first investor paid ₹2 crore for 20% with a 1× non-participating liquidation preference. In a simplified ₹3 crore sale, the investor can take the ₹2 crore preference or convert and take 20%, which would be ₹0.6 crore. The investor chooses ₹2 crore; ₹1 crore remains for the other holders. In a ₹20 crore sale, conversion yields ₹4 crore, so conversion is better than the ₹2 crore preference.

This illustration changes if the contract includes participation, multiple preferences, cumulative rights, senior rounds, dividends, carve-outs, debt, transaction costs, or different conversion mechanics. “One-times preference” is a label. The distribution waterfall is the evidence.

Keep a cap table that can survive diligence

The cap table should reconcile authorised, issued, paid-up, outstanding, reserved, granted, vested, exercised, cancelled, and fully diluted interests as applicable. For every holder or instrument, record class, count, percentage, price, date, vesting, transfer restrictions, special rights, approvals, and source documents. Reconcile it to statutory registers and financial records. Casual equity promises belong in the same risk register as unsigned debt guarantees: both can become permanent claims. Before accepting a valuation, run at least three exit values, a no-next-round case, the expected next-round dilution, the preference waterfall, and founder or employee exercise/tax cash needs. A high headline valuation can make the next round harder if evidence does not catch up. A lower clean valuation can be superior to a higher one with control rights or preferences that dominate the economics.

RED LINE Professional handoff. A qualified CA should review valuation, accounting, and tax assumptions; a practising CS should verify approvals, registers, issuances, and plan compliance; and an independent lawyer should review securities, preference, transfer, employment, and exit terms. Check the current Indian law and official requirements on the action date.

· EF pp. 90–94 · TABLE pp. 51–59 · RM pp. 61–65 · GE chs. 20, 26. Mechanisms paraphrased; Kaveri Systems, its cap table, valuations, and exits are explicitly fictional worked arithmetic. Legal and tax effects require current professional review.