Below you will find a list of terms and explanations to get you acquainted with the key concepts of startup investing:
Acquisition
When one company buys a controlling stake in another company.
B2B
Business to business. This describes a business that is targeting another business with its product or services. B2B technology is also sometimes referred to as enterprise technology.
Buyout
A common exit strategy. The purchase of a company's shares that gives the purchaser controlling interest in the company.
Convertible Loans
An alternative form of financing from equity financing: rather than a purchase of shares, the investor’s investment initially works as a loan to the company, with an agreed upon interest rate, which will then convert into shares at a future equity round. Convertible loans are often used for early stage investments, to spare the young company from having to declare a set valuation. Convertible loans may also be bridge loans – to give a company money in between formal rounds of financing.
Due Diligence
An analysis of all the facts and figures of a potential investment. Includes 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.
Employee Stock Option Plan (ESOP)
ESOP refers to the pool of available stock options which a company reserves for its employees as an incentive for loyalty with the company. A company will therefore make sure that the employees’ stock options will not be exercisable immediately but rather will “vest” over several years of employment. Investors will examine a company’s ESOP percentage and policy for two reasons:
- to see how much of the company’s capital is reserved for the employee’s shares, and therefore to get a complete picture of the company’s valuation.
- to ensure that the company is responsibly maintaining its capital without giving away too much.
A typical term sheet will therefore include the percentage of the company’s ESOP in the company’s valuation for purposes of determining the share purchase price and will also provide the vesting schedule.
Exit
The method by which an investor and/or entrepreneur intends to "exit" their investment in a company. Commons options are an IPO or buyout from another company. Entrepreneurs and VCs often develop an "exit strategy" while the company is still growing.
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.
Incubator
An organization that helps develop early stage companies, usually in exchange for equity in the company. Companies in incubators get help for things like building their management teams, strategizing their growth, etc.
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."
Liquidation Preference
Liquidation preference gives a preferred shareholder priority in line for distribution of the company’s assets in the event the company has a liquidation event. For example, if the company liquidates and distributes dividends, the preferred shareholder will be first in line ahead of ordinary shareholders and be entitled to a certain percentage of dividends before the rest are distributed. Likewise, when there are several classes of preferred shareholders, the highest class of preferred shareholder will be given priority over the lower classes.
Mezzanine Financing
A form of hybrid capital typically used to fund adolescent and mature cash flow positive companies. It is a form of debt financing, but it also includes embedded equity instruments or options. Companies at this level, which are no longer considered startups but have yet to go public, are typically referred to as "mezzanine level" companies.
NDA
Non-disclosure agreement. An agreement between two parties to protect sensitive or confidential information, such as trade secrets, from being shared with outside parties.
Pivot
The act of a startup quickly changing direction with its business strategy. For example, an enterprise server startup pivoting to become an enterprise cloud company.
Portfolio Company
A company that a specific venture capital firm has invested in is considered a "portfolio company" of that firm.
Post Money Valuation
Valuation is how much the company is worth as determined by several factors. Pre-money valuation refers to a company’s value before receiving funding. Post-money valuation is the company’s valuation after receiving the financing. For example, if an investor agrees to a pre-money valuation of $10M for a company and they decide to invest $5M, the company’s post-money valuation is $15M.
Preemptive Rights
A preemptive right is the right of existing shareholders to maintain their percentage ownership interest in the company if the company proposes to offer new equity securities to a third party.
Preferred Shares
Preferred shares in a private company are a class of stock that provides certain rights, privileges, and preferences to investors. Compared to common stock, which is normally held by the founders, it is a superior security. Preferred stock takes its name from a critical feature of preferred stock called liquidation preference. Liquidation preference means that in a liquidation event (i.e., a sale or IPO), the preferred stock holders will have the option of taking their cost out or sharing in the proceeds with the founders as common stock holders. For example, if the value of the sale of the company is below the valuation the preferred investors paid, then they will get their money back. If the sale is for more than the valuation the preferred investors paid, then they will get the percentage of the company they own. Preferred shares themselves can come in several classes, with priority given to the most recent class of preferred shares.
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.
Pro Rata Rights
From the Latin 'in proportion.' Pro rata rights gives an investor the option to 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
Return on investment. This is 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 $2M for a 20% share in a company and that company is bought out for $40M, the VC's return is $8M.
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. In rare cases rounds can go as far as Series F.
SaaS
Software as a service. A software product that is hosted remotely, usually over the internet (a.k.a. "in the cloud").
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.
Sector
The market that a startup companies product or service fits into. Examples include: consumer technology, cleantech, biotech, and enterprise technology.
Series
Refers to the specific round of financing a company is raising. For example, company X is raising their Series A round.
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.
Startup
A startup company is a company in the early stages of operations. Startups are usually seeking to solve a problem of fill a need, but there is no hard-and-fast rule for what makes a startup.
Term Sheet
An 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.
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.
Warrants
A warrant is an option that existing shareholders in a company have (in the form of a contract) to buy shares in that same company at a later time at an agreed upon price. The warrant holder may exercise this option up until a certain period of time.
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