Deconstructing the Cap Table

A seller hands you a deck. Enterprise value, $180 million. Equity value, $120 million. Net debt, $60 million. The numbers work. The problem: it's usually wrong, and by a wide margin.

Deconstructing the cap table is the first deep dive we do on any deal. Before the site visit, before the management call. The numbers tell a story. To put together a proper cap table, you need the latest balance, the Register of Members / Shareholders' Register (ideally from an independent source such as a corp sec, or regulatory agency), and the Shareholders' Agreement.

Build the stack layer by layer

For the debt, start with what's drawn, not what's committed. A $50 million revolver with $30 million drawn is $30 million of debt today. Make an assumption on the remaining $20 million. Can it be drawn? Are they likely to draw it? Who makes this decision?

Next, focus on what many analysts forget. For example, PIK interest accrues and compounds quietly. It doesn't appear on a cash flow statement. Shareholder loans, which sponsors freely call equity when it suits and debt when it suits. Guarantees given to a subsidiary's lender. These usually sit off the balance sheet, until the day the guarantee is called.

Lease obligations under the latest IFRS rules may not show up as debt, so they need to be added back. So do unpaid tax and payroll, which in most Asian jurisdictions attract penalties, interest and personal liability for directors. A $4 million delinquent payroll or tax payment is enough to turn a solvent-looking company into a workout.

Convertible instruments count twice, until you're certain. Model them as debt at face, then again as diluted equity. The gap in between is where you can sometimes negotiate.

Net cash carefully

Now subtract cash. Not all of it.

Cash sitting in an operating subsidiary in Indonesia or India is not cash at the holdco. Getting it up requires dividends, withholding tax, minority consent and sometimes a central bank. Haircut it or exclude it.

Restricted cash is not cash. Deposits pledged against bank guarantees, escrowed retentions, customer advances held on trust: none of that is available. Working capital float is more subtle. A business that shows $12 million on 31 December because it collected hard and paid nothing may only ever hold $3 million on a normal Tuesday.

We net average cash across a quarter, not the balance sheet date. The difference between the two tells you something about the finance director, or to whom the finance director reports.

Add equity at the right value

Equity goes in by class, not as a single line. Preferred with a 1x participating liquidation preference behaves like debt in most outcomes. Preferred with an 8% cumulative dividend and four years of accrual is really debt.

The last round's price is not the right value. Today's market price is the right value.

Price each class across a range of exit values, and pay attention to which class is out of the money. Those holders behave differently, which is a nicer way of saying they can be problematic.

Mark the debt to market

Face value is what is owed. It is not how you calculate proper Enterprise Value.

Debt in a stressed business often trades at a discount. The senior might change hands at 92 whereas second liens at 45. Nobody bids for shareholder loans, but the documentation can also be problematic in a workout.

Getting the right prices enables you to calculate Enterprise Value accurately. Very few analysts, aside from those with distressed debt experience, will understand the real importance of this exercise.

It tells you which claims get repaid in full, which in part, which convert in a restructuring and ends up owning the business. It also tells you which claims are goose eggs. Event driven debt investors have different targets versus vultures who want to control the business post workout.

Most analysts don't do this. They take the debt at face value off the balance sheet, subtract cash, add in book value (or market cap if there is one) and call it enterprise value. That's an excel formula, not valuation. The correct analysis requires knowing where the debt trades, which is usually not public. It requires relationships.

Don't rely on the numbers in the pitch deck

For example, the deck might show $78 million of debt and $180 million of enterprise value. However, adding in the other obligations we highlighted, marking the debt to market, adjusting for true available cash and the enterprise value might actually be closer to $70 million. Nothing about the business changed between $180 million and $70 million, it's the same business, just marked to market.

Control is different

Economics and control usually sit in different hands. A holder with 4% of the economics can hold a class veto over any sale, any new money, any amendment to the articles. A lender with a small ticket can hold a blocking position.

The person who can stop a deal is the person you ultimately end up negotiating with. At times, they hold almost no value and have almost nothing to lose, which makes them expensive. Holders whose economic stake is worthless can still manage to get paid, because they can hold up consent.

The honest floor

This exercise is only as good as the documents you get. Guarantees can hide in board minutes. Side letters give one investor rights the shareholders' agreement never mentions. Intercompany balances get netted and become very hard to reconcile.

We build the picture over time. Due diligence is not a once and done event, it continues over the life of the investment.

Once you understand the cap table, then you read the covenants. That's where you find out what the borrower has promised, and how much of that promise is broken. We'll talk about covenants in our next Insight.