Demystifying Funding Demystifying Funding: Common Investment Terms

CommonCommon InvestmentInvestment TermsTerms

Get Ready for Funding Program Session 1 - Demystifying Funding Demystifying Funding: Common Investment Terms

Angel investor

Individual who provides a small amount of capital to a startup for a stake in the company. Typically precedes a Seed Round and usually happens when the startup is in its infancy.

Anti-Dilution Agreement

This stipulation also protects the investor. Should shares be sold or investment secured for equity from another party at a later date, the original investor's share in the business does not become diluted. There are two forms of anti-dilution which need to be understood:

Full Ratchet: In this scenario only the founders of the company dilute their share when securing future investment. If a third party agrees to invest money, the original investor's stake remains the same in terms of value and control, while the founders have to dilute theirs in order to offer equity to the new investor(s).

Weighted: Here, dilution of the original investor's stake does occur, but it is calculated against the number of shares offered to a new investor. Legal expertise is usually required in order to agree on how much dilution takes place. Anti-dilution agreements are offered under some circumstances, but can in some cases be seen as a hindrance to the entrepreneurial process.

Benchmark

The process by which a startup company measures their current success. An investor measures a company's growth by determining whether or not they have met certain benchmarks. For example, company A has met the benchmark of having X amount of recurring revenue after 2 years in the market.

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Board of directors

Although the executive ofﬁcers, such as the CEO and CFO, generally handle the day-today operations of the business, the board of directors is ultimately responsible for the management and oversight of a corporation. A board typically includes investors and mentors. Not all startups have a board, but investors typically require a board seat in exchange for an investment in a company. Most venture-backed companies hold regular board meetings approximately six to eight times per year, with additional special meetings scheduled as needed.

Bridge loan

Also known as a swing loan. Short-term loan to bridge the gap between major ﬁnancing.

Buyout

A common exit strategy. The purchase of a company's shares that gives the purchaser controlling interest in the company.

Capped notes

Refers to a "cap" placed on investor notes in a round of ﬁnancing. Entrepreneurs and investors agree to place a cap on the valuation of the company where notes turn to equity. This means investors will own a certain percentage of a company relative to that cap when the company raises another round of funding. Uncapped rounds are generally more favorable to an entrepreneur/startup.

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CAP Table

It’s short for the “Capitalization Table” and means a detailed list of exactly how much stock each entity or person owns. Think of it like a spreadsheet that simply lists names and percentage ownership stakes all adding up to 100%.

Common & Preferred Stock

There are many “classes” of stock that can be issued in a company. Each class may have its own rights and preferences. Investors typically get Preferred Stock which may give them preferences such as the ability to get their investment back ﬁrst before the rest of the Common Stock holders get their proceeds. Founders and Employees are usually left with Common Stock which typically means you’re the last person to get paid.

Convertible debt/note

This is when a company borrows money with the intent that the debt accrued will later be converted to equity in the company at a later valuation. This allows companies to delay valuation while raising funding in it's early stages. This is typically done in the early stages of a company's life, when a valuation is more difﬁcult to complete and investing carries higher risk. Each note has an interest rate and a maturity date.

Co-Sale Only

Also referred to as “tag-along rights”, this agreement stipulates that if a founder decides to sell their shares to a potential buyer, the original investor can demand that their shares are offered to the buyer for the same amount. If the buyer is unable or unwilling to purchase both founder and investor shares for the same price, then the founder cannot sell their stake. Again, this provides an element of control where an investor can put a halt on a sale or ensure that they receive a return on their investment when a founder sells up.

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Costs of Counsel

Investors ask for a certain amount of legal fees to be reimbursed. The typical range is $25-75,000. Don’t spend much time on this.

Debt ﬁnancing

This is when a company raises money by selling bond, bills, or notes to an investor with the promise that the debt will be repaid with interest. It is typically performed by latestage companies.

Dilution

The effect of giving someone else part of the company’s stock is considered “dilution”. It means that you are diluting your equity stake to make room for someone else. When you’re worried about “giving away the company” that’s called dilution.

Due diligence

An analysis an investor makes of all the facts and ﬁgures of a potential investment. Can include an investigation of ﬁnancial records and a measure of potential ROI.

Equity ﬁnancing

The act of raising capital by selling off shares of a company. An IPO is technically a form of equity ﬁnancing.

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Exit

It's the method by which an investor &/or entrepreneur intends to "exit" their investment in a company (& get rich!). Commons options are an IPO or buyout from another company. Entrepreneurs & VCs develop an "exit strategy" while still growing.

First Refusal

Other investors and startup founders who agree to this stipulation must offer to sell their shares to the original investor ﬁrst. If they decline, then they are free to sell their shares to the highest bidder. This offers an investor some control over who owns equity in a company.

Ground Floor

A reference to the beginning of a venture, or the earliest point of a startup. Generally considered an advantage to invest at this level.

IPO

Initial public offering. The ﬁrst time shares of stock in a company are offered on a securities exchange or to the general public. At this point, a private company turns into a public company (and is no longer a startup).

Lead investor

A venture capital ﬁrm or individual investor that organizes a speciﬁc round of funding for a company. The lead investor usually invests the most capital in that round. Also known as "leading the round."

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Leveraged buyout

When a company is purchased with a strategic combination of equity and borrowed money. The target company's assets or revenue is used as "leverage" to pay back the borrowed capital.

Milestones

Also known as “investment tranches,” this refers to an investor making their funds available in stages as the business reaches specific milestones. This helps to limit any risk of losing the entire investment amount for the investor, and ensures that the business is on track and meeting an agreed time-frame. While this option can be attractive to an investor, it is also difficult to manage as milestones can be unstable and ill-defined even when applied to a successful business. A startup may grow at an unexpected rate, and so funds may be required before a milestone is met. For this reason investors often make the entire amount available immediately.

Portfolio company

A company that a specific Venture Capital firm has invested in is considered a "portfolio company" of that firm.

Preferred stock

A stock that carries a ﬁxed dividend that is to be paid out before dividends carried by common stock.

Proof of concept

A demonstration of the feasibility of a concept or idea that a startup is based on. Many VCs require proof of concept if you wish to pitch to them.

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Pro rata rights

Also known as supra pro rata rights. Pro rata is from the Latin 'in proportion.' A VC with supra pro rata rights gives him or her the option of increasing his or her ownership of a company in subsequent rounds of funding.

Recapitalization

A corporate reorganization of a company's capital structure, changing the mix of equity and debt. A company will usually recapitalize to prepare for an exit, lower taxes, or defend against a takeover.

ROI

This is the much-talked-about "return on investment." It's the money an investor gets back as a percentage of the money he or she has invested in a venture. For example, if a VC invests $2 million for a 20 percent share in a company and that company is bought out for $40 million, the VC's return is $8 million.

Round

Startups raise capital from VC ﬁrms in individual rounds, depending on the stage of the company. The ﬁrst round is usually a Seed round followed by Series A, B, and C rounds if necessary.

Seed

The seed round is the first official round of financing for a startup. At this point a company is usually raising funds for proof of concept and/or to build out a prototype and is referred to as a "seed stage" company.

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Series

Refers to the speciﬁc round of ﬁnancing a company is raising. For example, company X is raising their Series A round.

Share Consent

In this scenario, also known as a “lock-up”, an investor must give their consent to a business if those running it wish to sell their shares at a later date. Startup investment often requires that the founders who came up with the idea stay in place, giving their passion and dedication to the project. A lock-up stipulation protects the investor from a startup entrepreneur selling up, after acquiring investment, to a third party who may not be what the investor is looking for.

Stage

The stage of development a startup company is in. There is no explicit rule for what defines each stage of a company, but startups tend to be categorized as seed stage, early stage, mid-stage, and late stage. Most VCs firms only invest in companies in one or two stages. Some firms, however, manage multiple funds geared toward different stage companies.

Stock Options

A common request from an investor is for a stock option – essentially a percentage of available shares in return for investment. Most investors will ask for a share in a company as standard. Depending on the amount, this could be anything from 1% to a majority stake of 51% or over. Once a majority stake has been achieved an investor essentially has control of a company. Most don't actually want this and instead opt for 15% - 30%, but this depends entirely on how much is being invested against the value of the company overall.

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Stock Option Pool

When a company takes on an investment, the investor will usually request (read: insist, strong arm, force, drop kick) that you allocate a certain percentage of the company’s shares to a Stock Option Pool for future employees. This sounds all well and good, but it comes out of your portion of the stock, not the investors. Stock Option Pools will range from as little as 5 points of equity to as much as 20 points.

Term sheet

A non-binding agreement that outlines the major aspects of an investment to be made in a company. A term sheet sets the groundwork for building out detailed legal documents. It indicates a strong interest to move forward, but it’s not the same as guaranteeing an actual deal gets done.

Valuation

The process by which a company's worth or value is determined. An analyst will look at capital structure, management team, and revenue or potential revenue, among other things.

Venture capital

Money provided by venture capital ﬁrms to small, high-risk, startup companies with major growth potential.

Venture capitalist

An individual investor, working for a venture capital ﬁrm, that chooses to invest in speciﬁc companies. Venture capitalists typically have a focused market or sector that they know well and invest in.

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Vesting

Vesting is a process by which you “earn” your stock over time, much like you earn your salary. The purpose of vesting is to grant stock to people over a ﬁxed period of time so they have an incentive to stick around. The rights typically gain value (vest) over time until they reach their full value after a predetermined amount of time. For example, if an employee was offered 200 stock unites over 10 years, 20 units would vest each year. This gives employees an incentive to perform well and stay with the company for a longer period of time.

Sources: https://www.techrepublic.com/article/glossary-startup-and-venture-capital- terms-you-should-know/ http://blog.onevest.com/blog/2015/5/21/understanding-the-terms-of-startup- investment https://www.startups.co/articles/common-angel-investment-terms https://microventures.com/vc-terminology

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