There is a lot of lingo out in the world. Some of it you can ignore. Some of it you should probably know.
Here are some key words and phrases you may want to familiarize yourself with if you are looking for investors in your business. It’s the lingo of investors and if you want them to join your world, you need to speak the language. Also, if you mix up understanding some of the terms, you could easily enter into a deal only to understand way down the road…how you screwed yourself out of your own company.
Acquisition: When one company buys controlling stake in another company. Can be friendly (agreed upon) or hostile (no agreement).
Accredited investor: An investor meeting defined standards of financial capacity to make a risky, illiquid investment. Generally includes institutions with a net worth of $5,000,000 or more, and individual investors who have a net worth over $1,000,000 or an annual income of $200,000 or more in each of the last two years, who also expect to earn that amount in the current year. Securities regulations limit the number of non-accredited investors who can invest in a private equity transaction.
Anti-dilution protection: Provisions in typical preferred stock purchase agreements that protect the investor from dilution in the event of stock splits, stock dividends or sales of stock at a price lower than that the investor paid. See full ratchet anti-dilution and weighted average anti-dilution.
Angel investor: An individual, or sometimes a group of individuals, who provides a financial investment to a startup for a stake in the company. Typically the investment precedes a Seed Round and usually happens when the startup is in its infancy. The investor expects a financial return and sometimes the personal fulfillment of watching or participating in the companies growth.
Asset: Anything tangible or intangible that has positive economic value, meaning it’s worth more than you owe on it, or is capable of being owned and controlled to produce value, meaning it can be sold for real money, is considered an asset. This includes cash, promised money/accounts receivable, actual property and business tools.
Benchmark: The key indicators through which a company measures current success. An investor usually measures the startup’s growth by watching if they meet certain benchmarks. For example, Startup A has met the benchmark of having X paying customers after 2 years in the market.
Board of directors: A group of individuals, elected by stockholders, chosen to oversee the affairs of a company. A board typically includes investors and mentors. Some boards participate in the day-to-day activity of early startups but usually they are responsible for major corporate decisions and actions. Not all startups have a board, but investors typically require a board seat in exchange for investment in a company.
Bootstrapped/Bootstrapping: A company is bootstrapped when it is funded by an entrepreneur’s personal resources or the company’s own revenue with no true investors. Evolved from the phrase “pulling oneself up by one’s bootstraps.”
Bridge financing/Bridge loan: An interim financing round that provides cash to a company that is anticipating either a larger financing round, a merger or an initial public offering.
Blue-sky law: State securities laws designed to protect investors, typically requiring registration of securities offerings.
Burn rate: Negative cash flow on a monthly basis: i.e., the amount of cash the company is “burning” per month.
Buyout: A common exit strategy or type of financing used to buy a controlling interest in the company from previous owners. it is often accomplished through a combination of borrowed capital and private equity. If the borrowed funds exceed the new capital invested it is called a Leveraged Buyout (LBO). If the managers of the business are buying it out it can be called a Management Buyout (MBO).
Capital: Financial assets currently available for use. Entrepreneurs raise capital to start a company and continue raising capital to grow the company.
Capital under management: The amount of capital, or financial assets, that a venture capital firm is currently managing and investing.
Cash flow: This is the actual cash the moves through a business from all sources less the cash expenditures over a given period of time, usually a month or year. Positive Cash Flow means there is more cash coming in to the business than going out. Negative Cash Flow means expenses outpace income. Finances that cannot be used are not counted in Cash Flow, including investments and accounts receivable
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 but are rare and often part of “Friends and Family Round” investing.
Cash-on-cash return: A measure of a return on investment that does not take the passage of time into account, calculated as the total cash returned from an investment divided by the amount invested and expressed either as a percentage or as a multiple.
Common stock: The basic unit of ownership in a corporation, typically having voting rights on election of directors and major corporate actions, and typically being the last to be paid if a company is liquidated.
Convertible debt: In short, this is a loan made to a company that will convert to stock for the lender. When a company borrows money from an individual or private funder, there can be an agreement that the debt accrued will be converted to equity in the company at a later valuation. This allows companies to delay valuation while raising funding in 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.
Convertible preferred stock: Stock with priority over the common stock, which can be exchanged, or converted, into common stock under specified terms and conditions.
Cumulative preferred stock: A stock that has a dividend that accumulates if not paid by the company and typically must be paid current before any dividend is paid on the common stock.
Debt Financing/Debt Security: 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 late-stage companies.
Dilution: Typically refers to the impact of an event, such as issuance of new shares, which results in an owner owning less of a company on a percentage basis.
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.
Enterprise: The term enterprise typically refers to a company or business (i.e. an enterprise tech startup is a company that is building technology for businesses).
Equity: Ownership in a business entity. Generally, stockholders’ equity is total assets minus total liabilities. Equity capital: Money invested in a business in exchange for an ownership interest.
Equity kicker: A right to take an ownership interest in a business at some point in the future, usually evidenced by a warrant or stock option, or the equivalent.
Equity financing: The act of raising capital by selling off shares of a company. An IPO is technically a form of equity financing.
Equity securities: Stock in a company, typically common or preferred.
Exit/Exit Strategy: This is an event, such as a sale of a company, an initial public offering (IPO), merger or buyout from another company. It allows investors and founders to realize a return in cash or marketable securities (stock). It is often called an “exit strategy” when the company is growing.
Full ratchet anti-dilution: An investor-friendly form of ant-idilution protection whereby if the company sells one or more shares of stock at a price lower than that paid by the investor, the investor is entitled to have its number of shares increased so the number of shares times the lower price equals the original number of shares purchased times the original purchase price. See weighted average anti-dilution.
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).
Lifestyle company: A term for a business that operates sufficiently well to support the management team, but not well enough to permit an exit that can generate a reasonable return to investors.
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.”
Nondisclosure agreement (NDA): An agreement by which an investor or other person agrees not to further disclose any confidential information they may learn about a company (sometimes also referred to as a Confidentiality Agreement).
Participating preferred stock: A form of preferred stock in which the investor receives both the right to a priority return and the right to a pro rata share with the common stock in profits or sale proceeds.
Post-money valuation: The value of a company just after an investment is made, including the new money invested in the company.
Pre-money valuation: The value of a company just prior to an investment of venture capital.
Preferred stock: Stock that carries a fixed dividend that is to be paid out before dividends carried by common stock. Typical preference features include a priority on liquidation of the company and priority in payment of dividends.
Private equity: Money invested by sophisticated, institutional, or accredited investors prior to an offering of securities to the general public through an initial public offering. Includes venture capital, as well as later-stage private investment, such as buyout, recapitalization, and mezzanine investment.
Private placement: Sale of securities that are exempt from the registration requirements of federal and state securities laws, or are otherwise allowed to be sold to limited numbers of’ investors under specified circumstances and not to the public.
Private placement memorandum: A written document describing an upcoming issue of securities and outlining the terms and conditions of sale and the risks associated with the business venture. Also called an offering memorandum.
Pro-forma: Projected financial statements for a business based on a set of assumptions about the performance of that business.
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.
Prospectus: The principal disclosure document of a public sale of securities.
Public offering: Sale of new securities to the public, subject to regulatory requirements
Recapitalization: A restructuring 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.
Round: Investment in an early stage business usually comes in “rounds”, or pools of capital invested at about the same time. A typical sequence of rounds might be: friends and family round, seed stage round, first round, second round, expansion round, and mezzanine round.
- Friends and family round: Usually the first source of capital for an entrepreneur starting a business is the people close to the entrepreneur, who are willing to invest for personal or family reasons. There should be formal agreements made so that everybody understands who will get paid back and when.
- Seed round: The earliest stages of a new business, in which the entrepreneur develops and proves a concept for a product or service and determines whether it might support a successful business.
- First round: A financing round for companies that have passed the start-up phase, have developed a marketable product or service, and are ready to ramp-up to begin to generate revenues. Usually follows a “friends and family” round, a Startup/Seed stage round, or both and is followed by a Second Round or Expansion Round.
- Expansion round: Investment in a company that is already established and is seeking additional capital for growth. Typically includes rounds from the second round to the mezzanine round.
- Mezzanine investment: An investment made later in the growth cycle of a company, usually after the initial venture capital rounds and in anticipation of, an initial public offering or merger. It is sometimes considered to be within the broad definition of venture capital. Often companies at this level are no longer considered startups but have yet to go public.
Run rate: Measures the annualized rate of revenues derived by taking the revenues for the most recent quarter (or month) and multiplying by 4 (or 12).
Secondary public offering: When a company offers up new stock for sale to the public after an IPO. Often occurs when founders step down or desire to move into a lesser role within the company.
Startup: A startup company is a company in the early stages of operations. Startups are usually seeking to solve a problem or fill a need in the market, but there is no hard-and-fast rule for what makes a startup. A company is considered a startup until they, or their funders, stop referring to themselves as a startup.
Sweat equity: Value in a business derived from hard work and know-how rather than from investment of capital.
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 and is typically subject to due diligence.
Treasury Stock: Stock that has been issued and reacquired by a corporation but is not outstanding.
Undercapitalized: A business is said to be undercapitalized if it does not have enough money available to it to maintain continuing operations for the foreseeable future. This is one of the largest reasons for new company failure.
Valuation: The process of determining the value of a business or company. It will include things like capital structure, management team, and revenue or potential revenue.
Venture capital: Money provided by venture capital firms to small, high-risk, startup companies with major growth potential. Broadly defined, the term refers to any money invested by private investors (other than the entrepreneur or primary owner) to finance the early and growth stages of a business enterprise up through initial public offering or sale of the business.
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.
Vesting: When an employee of a company gains rights to stock options and contributions provided by the employer. The rights typically gain value (vest) over time until they reach their full value after a pre-determined amount of time. For example, if an employee was offered 200 stock units 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.
Walking dead: Slang term for companies in a venture capital portfolio that have neither failed nor met expectations. They may be doing too well to abandon, but exit opportunities may be scarce.
Weighted average anti-dilution: A form of anti-dilution protection in which a preferred investor’s stake in a company is adjusted for stock issued at a lower price by weighting the adjustment based on the amount of stock issued at the lower price. Unlike full ratchet anti-dilution, under which the sale of a single share of stock at a lower price allows the preferred investor to convert its entire position at the lower price, weighted average anti-dilution adjusts the conversion price based on a formula that takes into account the amount of stock sold at the lower price, thereby reducing the impact on common stockholders.
Working capital: Money available to a business for its everyday operating needs, usually calculated as current assets less current liabilities.
Other Business Terms:
B2B: Business to business. This describes a business that is has a target market of another business in order to sell its product or services. B2B technology is also sometimes referred to as enterprise technology.
B2C: Business to consumer. This is when a business sells products and services to an individual customers.
Accounts receivable: This is a legally enforceable claim for payment from a business to its customers/clients for products sold or services rendered. It is usually in the form of an invoice. Accounts receivable are considered assets.
Accounts payable: Money owed by a business to its suppliers. These are considered liabilities but do not include loans or other debts created through legal means (mortgages, rents, etc)
C-Corporation: A business registered as a corporation that is taxed as a separate entity under Subchapter C of the Internal Revenue Code.
Disruption: An innovation or technology “disrupts” an existing market by doing things such as: challenging the prices in the market, displacing an old technology, changing the market audience, or changing the way the market audience acts.
Limited liability company (LLC): A statutory structure for a business that offers the limited liability of a corporation along with the flow-through tax structure applicable to a partnership
Limited liability partnership (LLP): A business entity managed by a general partner with most of the rights of ownership concentrated in limited partners, whose liability is limited to the amount of their investment. Unlike a corporation, tax liability passes through to the partners.