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This is a comprehensive list of terms and definitions related to venture capital financing and investing. It covers all the key concepts, techniques, and practices involved in the venture capital industry, from early-stage funding to exit strategies. The glossary is a valuable resource for entrepreneurs, investors, and finance professionals who are looking to expand their knowledge of the venture capital landscape. By providing clear definitions of common terms, this glossary helps to demystify the world of venture capital and makes it easier for people to understand the various aspects of this dynamic industry.
An accredited investor is a term used by the US Securities and Exchange Commission (SEC) to define an individual or entity that meets certain criteria for financial sophistication. Accredited investors are considered to have the financial capability to bear the economic risk of investing in unregistered securities. To be considered an accredited investor, an individual must have an annual income of at least $200,000 (or $300,000 combined with a spouse) in each of the past two years, and expect to earn the same in the current year, or have a net worth of over $1 million, excluding the value of their primary residence. The term is used in the context of private securities offerings and refers to the eligibility criteria for investing in these types of investments.
Anchor investor is a term used in venture capital to refer to a leading or strategic investor who provides the initial funding for a startup and sets the tone for future investment rounds. The anchor investor often plays a critical role in the company's growth and future success, and can provide valuable support, connections, and expertise. An anchor investor typically invests a large sum of money, which helps to establish the company's credibility and attract additional investment from other venture capital firms or investors.
An angel investor is an individual or group of individuals who provide financial backing to startups, usually at the seed or early stage of a company's development. They typically invest their own money, as opposed to institutional investors, and provide not only capital but also valuable industry knowledge and network connections to the companies they support. Angel investors are often successful entrepreneurs themselves and are motivated by the potential for high returns and the excitement of helping new businesses succeed. You can learn about the key differences between VCs and angels here.
Anti-dilution protection refers to the measures taken by investors to protect their investment from being diluted in value in case of a down round (when a company raises capital at a lower valuation than its previous round). This protection can be achieved through anti-dilution clauses in the terms of the investment, such as weighted average anti-dilution or full ratchet anti-dilution. The purpose of anti-dilution protection is to ensure that the investor's ownership percentage in the company remains constant despite a decrease in the company's valuation.
An anti-dilution clause is a provision in a company's stock issuance agreement that protects the value of an investor's investment in the event of subsequent issuances of new shares at a lower price. This clause allows the original investors to receive additional shares to compensate for the dilution of their ownership stake due to the issuance of new shares at a lower price. This helps maintain the relative value of the original investment. The most common types of Anti-Dilution Clauses are Full Ratchet, Broad-Based Weighted Average, and Narrow-Based Weighted Average.
Annual recurring revenue (ARR) refers to the amount of predictable recurring revenue generated by a company on an annual basis. This revenue is typically generated from subscription-based or recurring business models. ARR is a key metric for evaluating the performance and growth of a company, and is often used by investors and lenders to assess the risk and potential of an investment.
Annual recurring revenue growth (ARRG) is a metric that measures the increase in a company's annual recurring revenue over a given period of time. It is used to assess the growth rate of a business and is typically expressed as a percentage. This metric is particularly important for subscription-based businesses where a large portion of the company's revenue is recurring, as it provides an indication of the company's ability to retain customers and grow its revenue base over time.
Annualized run rate (ARR) is a financial performance metric that projects the expected annual revenue of a company based on its current monthly or quarterly performance. ARR is calculated by multiplying the current monthly recurring revenue (MRR) by 12. This metric is used to predict future revenue and assess a company's growth potential, and is commonly used in the software-as-a-service (SaaS) industry.
Annualized Monthly Recurring Revenue (AMRR) is a metric that predicts a company's revenue by multiplying the monthly recurring revenue (MRR) by 12. It provides a forecast of a company's revenue in the upcoming year and is used to track the growth of a company's recurring revenue over time. This metric is commonly used in the software as a service (SaaS) industry to evaluate the stability and predictability of a company's revenue stream.
Blue Sky Laws refer to state-level securities regulations aimed at protecting investors from fraud and ensuring fair and honest securities transactions. These laws typically require companies to register their securities offerings with the state and provide certain disclosures to potential investors, such as financial statements and business plans. The goal of blue sky laws is to provide investors with enough information to make informed investment decisions and to prevent unscrupulous companies from raising funds through fraudulent or misleading securities offerings. The term "blue sky" refers to the idea that these laws are intended to protect investors from investing in "worthless" securities, similar to how the blue sky provides a clear and unlimited view of the horizon.
A bridge loan is a short-term loan that provides interim financing until a more permanent form of financing can be obtained. The loan is usually used to "bridge" a gap between a short-term need for funding and the receipt of other funds. In the venture capital context, bridge loans are often used to provide temporary financing to a company while it waits for a longer-term investment or loan to be approved and funded. Bridge loans typically come with higher interest rates than traditional loans, as they are meant to be a stop-gap solution.
A bridge round is a type of funding round for startups that is meant to bridge the gap between a company's current stage and its next financing round. The purpose of a bridge round is to provide a company with enough capital to keep operations running and make progress towards its goals until it can secure a larger funding round. The terms of a bridge round are often negotiated between the company and the investor and can include equity, debt, or a combination of both.
Bootstrapping refers to starting a business without the help of outside investors, instead relying on one's own resources, such as personal savings, income from a job, or loans from friends and family. The goal of bootstrapping is to reduce financial risk and maintain control over the company, as well as to prove the viability of the business model before seeking outside investment. This approach can be particularly useful for entrepreneurs who are just starting out, or who are looking to test their ideas and validate their market before seeking more substantial funding.
A Capital Call is a request by a venture capital (VC) firm or private equity (PE) fund manager to its limited partners (LPs) to contribute additional capital to the fund, typically to finance portfolio companies' operations or follow-on investments. Capital calls are typically included in the limited partnership agreement signed between the fund manager and its LPs.
Carried Interest is a share of the profits in a private equity or venture capital investment that is paid to the fund's management team, usually as a percentage of the total profits. It is meant to compensate the investment managers for their role in selecting, monitoring and exiting investments. The carried interest is typically paid only after the limited partners have received their initial investment back and a preferred return on their investment.
A Cap Table, also known as a Capitalization Table, is a document that shows the current ownership structure of a company, including the equity ownership of each shareholder and the number of shares they own. It also shows the company's outstanding debts and liabilities, and the conversion terms of any convertible securities. The Cap Table is an important document for startups, as it provides valuable information for making business decisions and for communicating with potential investors.
Churn rate is a metric used to measure the rate at which customers cancel their subscriptions or stop doing business with a company. It is calculated by dividing the number of customers lost during a certain time period by the total number of customers at the beginning of that period. Churn rate is an important metric for subscription-based businesses and companies with recurring revenue, as it helps to measure customer satisfaction and the effectiveness of retention strategies. High churn rates can indicate a problem with the product or service, while low churn rates suggest customer satisfaction and stability.
A clawback in venture capital refers to a provision in an investment agreement that requires the return of funds or equity in the event of certain circumstances. This provision may be triggered when an investor discovers that the information provided by the company was misleading, or if the company violates the terms of the investment agreement. Clawbacks can be used to mitigate the risk of investment and protect the interests of investors.
Cliff is a term used in the startup world to describe a condition or event that must occur before an employee or founder is eligible to receive a specific benefit, such as equity, a bonus, or vesting of stock options. For example, a "vesting cliff" is a requirement that the employee must remain with the company for a specified period of time, usually one year, before any stock options will vest. If the employee leaves the company before the cliff period is over, they will not receive any of the vested stock options.
Come along rights refer to a provision in a shareholder agreement that gives a majority shareholder the right to force the minority shareholders to sell their shares along with the majority shareholder if the majority shareholder decides to sell their shares. The purpose of come along rights is to ensure that the minority shareholders do not have the power to block a potential buyer from acquiring the majority of the company's shares.
Control rights refer to the rights of an investor or a group of investors to have significant control over the operations and decision-making of a company, usually in exchange for their investment. These rights are usually specified in a company's bylaws, shareholder agreements, or other corporate governance documents and can include voting control, board representation, and approval rights for major decisions such as acquisitions, mergers, and financing rounds. Control rights can impact the balance of power and decision-making within a company and can have significant implications for its future direction and success.
A covenant refers to a clause in a loan or investment agreement that requires the borrower or investee to fulfill certain conditions or refrain from certain activities. These stipulations are intended to protect the investor or lender by managing risks and ensuring that the borrower or investee maintains a certain level of operational stability and financial health.
Covenants can be positive (affirmative) or negative (restrictive):
Positive/Affirmative Covenants are actions that the borrower or investee agrees to undertake during the life of the loan or investment. For example, they might agree to maintain certain financial ratios, such as a certain debt-to-equity ratio, or to provide regular financial statements to the investor.
Negative/Restrictive Covenants are actions that the borrower or investee agrees to avoid. These can include things like not taking on additional debt, not merging with another company without the investor's approval, or not selling major assets without consent.
In the venture capital context, if a company breaches a covenant, it can trigger a default, leading to potential penalties, a renegotiation of terms, or even an acceleration of the repayment schedule. However, venture capital covenants tend to be less strict than those in traditional lending contexts, as venture capitalists often expect more volatility and risk from their portfolio companies.
A convertible bond is a type of debt security that can be converted into a predetermined amount of the issuer's equity at certain times during its life, usually at the discretion of the bondholder. This feature gives the bondholder the potential for upside gain if the company performs well and its stock price increases.
Convertible bonds are a flexible financing option that can be attractive to both companies and investors. For companies, convertible bonds can be a way to raise capital at a lower interest rate, as the conversion feature is an added value for the investor. For investors, convertible bonds can offer the regular interest payments and lower risk of bonds, with the added potential for capital appreciation if they convert their bonds into stock.
The specific terms of the conversion — such as the conversion price (the price at which the bond can be converted into stock), the conversion ratio (how many shares can be obtained per bond), and the conversion periods (when conversion can take place) — are defined at the time of issuance of the bond.
If the company's share price does not exceed the conversion price as the bond's maturity date approaches, the bondholder may simply choose to have the principal repaid, as in a traditional bond. However, if the company's share price has exceeded the conversion price, the bondholder may choose to convert the bond into shares, which can then be sold for a profit.
Convertible debt is a type of loan provided by investors to a company with the understanding that the debt will either be paid back in the future or converted into equity in the company.
The conversion of debt into equity typically happens during a future financing round (such as an equity round), and the terms of conversion, including the conversion ratio, will be specified in the convertible debt agreement. The conversion ratio is often determined by the price of the equity in the future financing round, potentially with a discount rate or a valuation cap to reward the convertible note holders for their early investment and the higher risk they took on.
This form of financing is commonly used in early-stage startups. For the startups, it allows them to delay setting a valuation until they have more operating history, usually at the time of the next funding round when it could potentially be higher. For the investors, convertible debt can offer the security of a debt instrument, with the potential upside of converting into equity.
Key features often associated with convertible debt include:
Discount Rate: This gives convertible debt holders the right to convert their debt into equity at a price that is less than what later investors will pay in the next financing round.
Valuation Cap: This is a pre-set price that puts a limit on the conversion price of the debt, which could provide significant upside if the company's valuation at the next financing round is above the cap.
Interest Rate: Like traditional loans, convertible debt usually carries an interest rate. The accrued interest is typically added to the principal amount when calculating the conversion into equity.
Maturity Date: This is the date when the debt is due to be repaid if not converted into equity. Some agreements may stipulate automatic conversion into equity at the maturity date if it's not already converted.
Conversion Triggers: Specific events, often a qualified financing round (a round that raises over a certain amount), that cause the automatic conversion of the debt into equity.
A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round. Essentially, it's a loan that is designed to convert into ownership or shares in the company instead of being repaid in cash.
Convertible notes are commonly used in seed financing by startups as they can be quicker and cheaper to issue than equity, and they defer the need to determine the company's valuation to a later time when more information will be available to make an accurate assessment.
Key features of a convertible note include:
Principal Amount: This is the initial amount of the loan that will be converted into equity.
Interest Rate: Like other forms of debt, convertible notes accrue interest over time. However, instead of being paid back in cash, the interest increases the number of shares issued upon conversion.
Maturity Date: The date when the note is due. If not converted into equity, the company must repay the note at this time, although in practice, repayment at maturity is rare with convertible notes.
Discount Rate: This is a feature that rewards the early investors for the risk they're taking. It allows convertible note holders to convert their debt into equity at a price lower than what later investors pay in the next financing round.
Valuation Cap (or Conversion Cap): This sets a maximum company valuation at which the note will convert into equity. A cap is beneficial for early investors if the company's valuation at the next financing round is much higher than when the note was issued.
Conversion Trigger: This is an event, typically a qualified financing round (a round that raises over a certain amount), that leads to the automatic conversion of the note into equity.
Convertible notes are a popular choice for early-stage startups due to their simplicity and flexibility. They provide startups with a way to raise funds without immediately establishing a valuation, and they give investors the opportunity to eventually own a piece of the company.
A cumulative dividend is a provision that accompanies preferred shares of a company, stipulating that if any dividends have been omitted or not fully paid in the past, they must accumulate and be paid out to preferred shareholders first, before any dividends are paid to common shareholders.
Preferred shareholders with cumulative dividend rights are entitled to be paid any unpaid or skipped dividend payments before any dividends are paid out to common shareholders. This accumulation of unpaid dividends can happen when the company decides to skip a dividend or when it's unable to pay a dividend in a particular period due to financial constraints.
This feature provides an extra layer of protection to preferred shareholders, ensuring that their right to receive dividends is respected even during tough financial times for the company. If a company with cumulative preferred shares fails to pay a dividend, or pays less than the agreed-upon amount, the owed dividends are said to be "in arrears," and must be paid out before any dividends can be distributed to common shareholders.
It's important to note, however, that not all preferred shares have cumulative dividend rights.
Cutback rights, also known as "clawback" rights, are contractual provisions that allow an investor or group of investors to reclaim a portion of their investment under certain conditions. These rights are often negotiated in venture capital and private equity deals, as well as in other types of financial transactions.
In a venture capital context, cutback rights often refer to a situation where existing investors have the right to participate in future financing rounds of a company. If a new investor wants to invest and the company doesn't want to overly dilute its shares, the company might need to "cut back" on the shares issued to the new investor in order to allow the existing investors to maintain their proportional ownership in the company.
However, the term "cutback rights" isn't universally standardized and its meaning can vary depending on the context and the specific terms of the investment agreement. Therefore, it's always important to fully understand the terms of an agreement when investing in a private company.
Customer Acquisition Cost (CAC) is a key business metric that represents the cost of acquiring a new customer. It is particularly important for businesses that rely heavily on upfront customer acquisition efforts, such as many online or subscription-based businesses.
The formula to calculate CAC is:
CAC = Total cost spent on acquisition / Number of customers acquired
In this formula, "Total cost spent on acquisition" typically includes all marketing and sales expenses (including salaries and overheads for these departments), and any other costs directly related to customer acquisition during a specific period. The "Number of customers acquired" refers to the total new customers gained during the same period.
CAC is a crucial metric in determining the profitability of a company. If the CAC is higher than the lifetime value of a customer (LTV), the company could be losing money for each customer acquired, which is clearly unsustainable in the long run. Therefore, companies aim to have a LTV/CAC ratio greater than 1, indicating that the value derived from a customer is greater than the cost of acquiring them.
Reducing CAC, increasing customer lifetime value, or both, are common goals in improving a company's profitability and efficiency.
Deal flow refers to the rate at which business proposals and investment pitches are being received by financiers such as venture capitalists, private equity firms, or investment bankers. These proposals could be for anything from startup financing to merger and acquisition proposals.
Maintaining a robust deal flow is critical for these investors because it provides them with a wide array of opportunities to consider and choose from. A more diverse deal flow means investors can be more selective, thereby potentially improving their chances of successful investments.
Investors can generate deal flow from various sources such as:
Networking: Building relationships with entrepreneurs, attending industry conferences and events, and leveraging personal connections.
Cold Outreach: Contacting companies or entrepreneurs directly to discuss potential investment opportunities.
Accelerator Programs: Participating in or partnering with startup accelerator or incubator programs which aim to develop early-stage companies.
Syndicate Partners: Working with other investors or firms who may share relevant deals.
Online Platforms: Utilizing online platforms and databases that connect investors with startups looking for funding.
An investor's deal flow can often be a key indicator of their access to high-quality investment opportunities and their standing within the investment community. However, the quality of the deal flow is just as, if not more, important than the quantity.
In the context of finance and investing, distributions refer to payments made by a corporation to its shareholders, typically in the form of cash (cash dividends) or additional stock (stock dividends). Distributions can also come in the form of products or other assets.
In the private equity and venture capital space, distributions are the funds returned to the investors from their investment in a portfolio company. These returns are often generated from one of three events:
Dividends: Similar to publicly traded companies, some private companies distribute profits back to investors in the form of dividends, although this is less common in growth-focused companies such as tech startups.
Sale of the Company: If the company is sold, the proceeds of the sale are distributed back to the investors, often providing the bulk of the return on their investment.
Public Offering: If the company goes public, investors can sell their shares on the open market and distribute the proceeds back to the limited partners.
Distributions are often managed through a waterfall structure, in which certain investors (like preferred equity holders) have priority to receive distributions before others (like common equity holders).
It's important to note that distributions in venture capital and private equity are typically more complex and less frequent than in publicly traded companies, as they are usually tied to significant company events like a sale or IPO, and subject to various terms of the investment agreement.
A down round refers to a financing event in which a company raises capital by selling its shares at a price that is lower than the price at which it sold shares during its previous financing round. This implies a decrease in the company's valuation, which is why it is called a "down" round.
Down rounds can occur when a company is unable to meet performance expectations, when its operating environment becomes challenging, or when wider market conditions are unfavorable. For existing shareholders, a down round can mean significant dilution of their ownership stake and a decrease in the value of their investment.
Down rounds can also negatively impact a company's morale, reputation, and future fundraising efforts. However, a down round can provide a crucial lifeline of funding to help a struggling company weather a difficult period, and may be preferred over more drastic alternatives such as bankruptcy or liquidation.
It's also important to note that some investors include "anti-dilution provisions" in their investment agreements, which protect them from dilution in the event of a down round. These provisions allow these investors to receive additional shares in a down round to maintain their percentage ownership in the company.
Down round protection, also known as an anti-dilution provision, is a clause in an investment agreement that protects an investor from the dilution of their ownership percentage in the event of a future down round.
A down round occurs when a company raises capital by issuing shares at a lower price than in the previous funding round, thus decreasing the company's valuation. This can lead to significant dilution of ownership for existing shareholders.
Down round protection clauses aim to mitigate this risk for investors. There are two common types of anti-dilution provisions:
Full Ratchet Anti-Dilution: This is the more investor-friendly provision. In a full ratchet scenario, the investor's conversion price (i.e., the price per share at which preferred stock can be converted into common stock) is adjusted down to the price at which the new shares are issued in the down round, irrespective of the number of shares issued in the down round. This means that the investor maintains their ownership percentage as if they had initially invested at the new, lower price.
Weighted Average Anti-Dilution: This is a less severe form of protection, where the conversion price is reduced based on both the price and the quantity of the new shares in the down round. This results in less dilution than there would be with no protection, but more dilution than under a full ratchet scenario.
While down round protection is beneficial for investors, it can lead to further dilution for founders and other shareholders who don't have such protection. Therefore, the negotiation of these provisions can be a significant aspect of fundraising discussions.
Drag along rights are a contractual agreement between shareholders of a company, which stipulate that if a majority of shareholders want to sell their shares to a potential buyer, the remaining minority shareholders must also sell their shares. This provision ensures that a potential buyer can acquire 100% of a company, not just the majority stake.
These rights are designed to protect the majority shareholders in the event of a sale. Without this provision, minority shareholders could refuse to sell their shares, making it harder to sell the company or potentially reducing the sale price if the buyer wants full ownership.
For the minority shareholders, while this provision may force them to sell when they might prefer not to, it also ensures that they get to sell their shares on the same terms as the majority shareholders.
Drag along rights are particularly common in venture capital and private equity investments, but can also be used in any situation where there are minority and majority shareholders. They are typically negotiated as part of a larger shareholders' agreement, and their exact terms can vary depending on the specific agreement.
Due diligence is a comprehensive appraisal process undertaken by a prospective buyer or investor to establish the assets and liabilities of a company, its commercial potential, and overall fit with the buyer's or investor's strategy. This process is done prior to buying a company, making an investment, or entering into a business arrangement.
The goal of due diligence is to validate claims made by the company (also known as the target), mitigate risks, and avoid potential legal issues. It's a critical step in making informed decisions regarding the value of the company and the viability of the investment.
Due diligence typically covers several areas, including:
Financial Due Diligence: This includes a thorough review of the target's financial statements, accounting practices, revenue projections, and other key financial indicators.
Legal Due Diligence: This involves reviewing contracts, employment agreements, legal disputes, intellectual property, and compliance with relevant regulations to ensure there are no potential legal issues.
Operational Due Diligence: This involves evaluating the company's business model, operations, products/services, and market positioning.
Technical Due Diligence: Particularly relevant in tech companies or startups, this involves evaluating the company's technology, including software, hardware, IP, and technical infrastructure.
Market/Commercial Due Diligence: This focuses on the market in which the company operates, its competitors, market size, trends, and the company's market share.
The complexity and duration of the due diligence process can vary widely based on the size and nature of the company and the deal. It can involve several different parties including accountants, lawyers, business consultants, and industry experts. The findings from the due diligence process can significantly influence the negotiation and final terms of the deal.
An employee stock ownership program (ESOP) is a type of employee benefit plan that provides workers with an ownership interest in the company by enabling them to own stock in that company. The basic idea is to allow employees to share in the wealth of the company, and potentially influence its governance depending on how the ESOP is structured.
Here's how it typically works:
The company sets up a trust fund and contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan.
The ESOP shares are allocated to individual employee accounts. While there are many ways of allocating the shares, the most common method is to do so in proportion to salary, or to balance the allocation more toward employees with lower pay and/or more years of service.
The employees cash out their shares when they leave the company or retire. Depending on the company's plan and policies, employees can either sell their shares back to the company directly or sell them on the market if the company is publicly traded.
An ESOP is a tax-advantaged method to provide employees with ownership interest in the company. For privately held businesses, it can also provide a market for the shares of departing owners. ESOPs can be found in many different types of companies, from small, privately held companies to large, publicly traded corporations.
However, it's important to note that while an ESOP provides employees with a financial interest in the success of the company, it does not necessarily mean that employees have control over the company's day-to-day operations. The level of employee influence on company operations depends on how the ESOP is structured and the rules of the specific plan.
It's also worth noting that while "ESOP" often refers to the kind of plan I just described, in some countries (like India), "ESOP" more commonly refers to an "Employee Stock Option Plan," which is a different kind of employee equity scheme.
An employee stock option plan (ESOP) is a program that provides employees the right to purchase shares in the company they work for at a predetermined price. These plans are often used as a tool for companies to attract, retain, and incentivize employees.
Here's how it generally works:
Granting of Options: The company grants stock options to employees, giving them the right to purchase a certain number of shares in the company at a predetermined price, known as the "strike price" or "exercise price." This price is often set at the fair market value of the company's stock at the time the options are granted.
Vesting Period: The options usually come with a vesting schedule that determines when the options can be exercised. For instance, a common vesting schedule is over four years, with a one year "cliff." This means that an employee must remain with the company for at least one year to earn any options, and thereafter, the options vest incrementally on a monthly basis.
Exercising the Options: Once the options have vested, the employee can exercise them, meaning they can buy the company's stock at the strike price. If the current market price of the stock is higher than the strike price, the employee can make a profit by exercising the option and then selling the stock.
Expiration: Stock options don't last forever, and they typically come with an expiration date. If the options are not exercised before this date, they are forfeited.
ESOPs can be an attractive element of a compensation package, as they give employees the potential to benefit from the company's success over time. However, they also come with risks, as the value of stock options is tied to the company's performance and the fluctuation of the stock's market price.
An employee option pool, also referred to as an "equity pool" or "option pool," is a block of a company's shares that are set aside for future issuance to employees, typically through an employee stock option plan. This pool of equity is used as part of the compensation package to incentivize and reward employees.
In a startup or early-stage company context, the size of the option pool is usually negotiated between founders and venture capital investors during funding rounds. This is because the creation or expansion of an option pool dilutes the ownership stakes of existing shareholders, including the founders and previous investors. Therefore, its size and terms are important elements of the negotiation.
The size of the option pool can vary depending on the company, its hiring needs, and its growth strategy, but it often ranges from 10% to 20% of the total outstanding shares. The pool is typically set up to be large enough to cover future hiring needs over a certain period (often until the next financing round), and may be replenished as necessary.
The shares in an option pool can be used to attract and retain key talent by offering potential hires the opportunity to share in the company's potential success. They are particularly common in startups and other high-growth companies, where the potential for significant increase in the company's value can make stock options a compelling part of an employee's compensation package.
An elevator pitch is a brief, persuasive speech that you can use to spark interest in what your organization does. The term "elevator pitch" reflects the idea that it should be possible to deliver the summary in the time span of an elevator ride, or approximately thirty seconds to two minutes.
The purpose of an elevator pitch is to give a concise, compelling overview of your business, project, or idea in a way that is easy to understand and engaging. It should convey who you are, what you do, and what you want to achieve, or how your product or service is beneficial. The ultimate goal is to engage your listener, spark their interest, and make them want to hear more.
Here's an example of an elevator pitch for a hypothetical startup:
"Our company, SafeHaven, uses artificial intelligence to provide personalized safety and emergency response solutions. Through a combination of wearable tech and a smartphone app, we offer real-time health monitoring and emergency services access, providing peace of mind for vulnerable individuals and their families. We're currently seeking seed investment to finalize product development and initiate our go-to-market strategy."
This pitch quickly communicates what the company does, the problem it solves, and a call to action (seeking investment).
Good elevator pitches are clear, concise, and compelling. They explain enough about your business to pique interest but leave room for the listener to ask for more information. They're also adaptable—you should be able to adjust your pitch depending on who you're speaking to and what you know about their interests or needs.
Exit velocity is a term often used in the context of venture capital and startup investing to denote the pace at which companies in a portfolio are sold or "exit". This can be through a variety of ways such as an initial public offering (IPO), a merger, or an acquisition. Exit velocity might refer to the speed at which these exits happen after initial investment, or the frequency of successful exits over a specific timeframe.
High exit velocity can signal a healthy startup ecosystem or a successful venture capital firm, as it typically means that companies are growing and becoming valuable quickly, leading to profitable exits.
However, the term "exit velocity" can be used in a number of different ways depending on the context, so it's important to understand exactly what aspect of exit activity is being referred to when the term is used. Nor is it a term that is commonly used in venture capital.
An Exempt Reporting Adviser (ERA) is an investment adviser that does not need to register with the Securities and Exchange Commission (SEC) because they meet certain requirements that allow them to be exempt from registration. This term is typically used in the United States.
There are two main categories of ERAs:
Venture Capital Fund Advisers: Advisers that only manage venture capital funds are exempt from registration. The definition of a "venture capital fund" is quite specific and includes requirements such as the fund not being leveraged, the fund only investing in certain types of securities, and the fund not offering its investors redemption rights.
Private Fund Advisers with Less Than $150 Million in Assets Under Management (AUM): Advisers who only manage private funds and have less than $150 million in AUM in the United States are also exempt from registration.
Despite being exempt from registration, ERAs must still comply with a number of SEC rules. They must still file certain reports on Form ADV (although they fill out fewer items than registered advisers) and they are still subject to SEC examination. The exact requirements can change, so it's important to consult with a legal expert or refer to the SEC's website for up-to-date information.
Keep in mind that state law often has its own requirements for investment advisers, so ERAs may still need to register under state law, even if they are exempt from federal registration.
Fair market value (FMV) refers to the price that a property or asset would sell for on the open market between a willing buyer and a willing seller, with both having reasonable knowledge of all the necessary facts, and neither being under any compulsion to buy or sell.
Fair market value assumes that the transaction is arm's length, meaning it's conducted between freely consenting, unrelated parties, each of whom is behaving in their own best interest.
Determining FMV can be complex, and there are various methods to do so depending on the asset in question. Some of these methods include:
Comparable Sales Method: For real estate or businesses, the prices of similar properties or businesses that have recently sold in the same area can be used as a basis.
Income Capitalization Method: For income-generating assets like rental properties or businesses, the potential income that could be generated from the asset can be used to determine its value.
Cost Method: For assets like machinery or equipment, the cost to replace the item with a similar one at its current condition and utility can be used.
Fair market value is used for a variety of purposes such as determining the selling price of a business, asset valuation in financial reporting, calculating property taxes, and in legal disputes over the value of assets.
In the context of venture capital, fiduciary duties most often come into play with respect to the venture capital firm's general partners and the board members of a portfolio company.
General Partners (GPs): The general partners in a venture capital firm have a fiduciary duty to the limited partners (LPs) - the investors who have provided the capital for the venture capital fund. This duty means that the GPs must act in the best interest of the LPs when making investment decisions. They should manage the fund’s assets prudently, disclose any potential conflicts of interest, and not enrich themselves at the expense of the LPs.
Board Members: When a venture capitalist takes a seat on the board of directors of a portfolio company, they assume fiduciary duties to act in the best interest of the company and all of its shareholders. This duty may sometimes conflict with the venture capitalist's duty to the LPs, especially in situations where the company is struggling. For example, in a sale of the company or in a decision to take on risky but potentially high-return projects, the best decision for the company and all of its shareholders might not be the best outcome for the venture capital fund.
Venture capitalists must navigate these potential conflicts of interest carefully and are legally obligated to do so. A failure to uphold these fiduciary duties can lead to legal liability and damage a venture capitalist's reputation in the industry. It is also worth noting that these duties can vary based on jurisdiction, so it's important for venture capitalists to understand the specific legal frameworks they operate within.
A follow-on investment, also known as follow-on funding, is an additional investment made by an investor in a company following the initial investment. This typically happens in later funding rounds after the investor has already invested in an earlier round.
Follow-on investments are often seen as a sign of confidence from the investor in the company's potential for growth and success. They can provide additional capital for the company to expand, develop new products or services, or enter new markets.
There are a few common scenarios where follow-on investments may occur:
Pro rata investment: This is when an investor chooses to maintain their ownership percentage in a company during a new funding round. Since issuing new shares dilutes the ownership of existing shareholders, these shareholders may have the right to make a follow-on investment to buy some of the new shares and maintain their original ownership percentage.
Opportunistic investment: This is when an investor increases their ownership stake in a company because they believe the company has significant growth potential. This often happens when the company is performing well and the investor wants to invest more capital to support its growth and increase their potential return.
Support investment: This is when an investor provides additional funding to help a company that is struggling. This can be a risky move, but the investor may believe that with additional capital, the company can overcome its challenges and eventually succeed.
Follow-on investments can be important for startups and other private companies that rely on multiple rounds of financing to grow their businesses. It's also an important consideration for venture capital and private equity investors as they manage their portfolios and capital commitments.
A fund of funds (FoF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds, or other securities. This type of investing is also referred to as multi-manager investment.
A fund of funds could be composed of various types of funds, including mutual funds, hedge funds, private equity funds, and others. The strategy aims to achieve broad diversification and appropriate asset allocation with investments in a variety of fund categories that are all managed by other investment firms.
In the venture capital context, a fund of funds typically invests in a portfolio of different venture capital firms. The goal is to gain exposure to a diverse range of companies in various industries and stages of development. This allows investors to potentially benefit from the performance of successful startups without having to identify and invest in these companies directly.
The primary advantage of this approach is that it provides a level of diversification that would otherwise be hard to achieve for most individual investors. However, it's important to note that this comes with a unique set of risks, including a layer of fees (since you're paying management fees to the FoF and to each individual fund in which it invests), and a potential for over-diversification that could dilute returns. It's also worth noting that the performance of a FoF heavily relies on the fund manager's skill in selecting the right mix of underlying funds.
Free cash flow (FCF) is a measure of a company's financial performance and health. It represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base.
FCF is important because it allows a company to pursue opportunities that enhance shareholder value, such as launching new products, making acquisitions, repaying investors, or paying back its debt. Companies with strong free cash flow can often make these investments while also growing their businesses, which can lead to increased profitability and value for shareholders.
FCF is calculated by subtracting capital expenditures from operating cash flow:
FCF = Operating Cash Flow - Capital Expenditures
Operating Cash Flow: This is the cash generated from a company's normal business operations. It can be found on a company's statement of cash flows.
Capital Expenditures (CapEx): This is the money spent by a company to buy, maintain, or improve its fixed assets, such as property, plant, and equipment (PP&E). This is also found on the cash flow statement.
It's important to note that a positive free cash flow is typically seen as a good sign, indicating that the company is generating more cash than is required to run the company and invest in its growth. However, a negative free cash flow isn't necessarily a bad thing, especially for fast-growing companies that are investing heavily in their own growth.
As with any financial metric, FCF should be used in conjunction with other metrics and understood within the larger context of a company's overall financial situation and strategy.
A General Partner (GP) is a person or entity that assumes management responsibility in a partnership and has full personal liability for the partnership's debts and obligations.
In the context of venture capital and private equity, a GP is typically a member of the investment firm who manages a fund. The GP has a fiduciary responsibility to the investors of the fund, who are typically known as Limited Partners (LPs). The GP's duties typically include sourcing and vetting investment opportunities, making investments, monitoring portfolio companies, and eventually orchestrating exits from investments through sales or IPOs.
GPs are compensated in two primary ways:
Management Fee: This is a fee paid by the fund to the GP for managing the fund's investments. It's usually a percentage of the fund's committed or invested capital and is intended to cover the GP's operating expenses.
Carried Interest: Also known as "carry," this is a share of the profits from the fund's investments that goes to the GP. It's typically a significant percentage of the profits and serves as the primary incentive for the GP to maximize the fund's returns.
Unlike LPs, GPs have personal liability for the actions of the partnership. If the partnership is unable to meet its financial obligations or is sued, the GP's personal assets could be at risk. However, in most venture capital and private equity funds, the fund itself is structured as a limited liability entity, which limits the GP's personal liability.
General Partner (GP) commitment refers to the amount of capital that the general partners of a venture capital or private equity fund contribute to that fund.
It's a standard practice in the industry for GPs to invest their own money into the funds they manage, alongside the capital from the Limited Partners (LPs). This is often seen as a way for GPs to show their confidence in the fund and align their interests with those of the LPs.
The amount of the GP commitment can vary but is typically between 1% and 5% of the fund’s total size. For example, if a fund's total capital commitments amount to $100 million, the GPs might collectively contribute $1 million to $5 million.
The GP commitment serves a number of important purposes:
Alignment of Interests: By having "skin in the game", GPs demonstrate that they are willing to share in both the upside and the downside risk of the fund's investments. This can provide LPs with greater confidence that the GPs will manage the fund prudently.
Confidence in Fund Strategy: GP commitment also serves as a signal to LPs that the GPs believe in the fund's strategy and in their ability to execute it successfully.
Fulfillment of Fiduciary Duties: By contributing their own money to the fund, GPs underscore their commitment to their fiduciary duties to the LPs.
While GP commitment is generally seen as a positive factor when raising a fund, it's also important to keep in mind that the amount of the commitment can vary widely based on a variety of factors, including the size of the fund and the financial resources of the GPs.
General solicitation is a term used in the context of securities regulation in the United States. It refers to the act of publicly advertising the sale of securities, which includes any form of communication like advertising, public media, seminars, or public speeches that reach out to the general public to offer buying securities (like stocks or bonds).
Traditionally, general solicitation has been prohibited under the Securities Act of 1933, specifically under Regulation D, Rule 506(b), in order to protect unsophisticated or non-accredited investors from potential fraud or financial loss.
However, under a rule adopted by the U.S. Securities and Exchange Commission (SEC) in 2013 known as Rule 506(c) of Regulation D, companies can engage in general solicitation when raising capital, as long as all investors who actually participate in the offering are accredited investors and the company has taken reasonable steps to verify that these investors are indeed accredited.
Accredited investors are individuals or entities that meet certain income, net worth, or professional experience thresholds established by the SEC, and are deemed capable of evaluating the merits and risks of their investments.
It's important to note that, while Rule 506(c) offers more flexibility in capital raising, it also imposes additional responsibilities on companies to verify the accredited status of their investors, which can be a complex process. Therefore, some companies choose to continue raising capital under Rule 506(b), which does not allow general solicitation but also does not require investor verification.
Grandfather rights, or grandfather clause, is a legal provision that allows an individual or entity to continue operating under an old set of rules or laws even when new regulations or laws have been implemented that have changed or updated these rules. These rights are typically granted to avoid disruptions or undue hardship that may come from sudden changes in law or policy.
In the context of venture capital, a grandfather clause may be used in a variety of situations. For example, if a VC firm changes its terms for follow-on investments, they might allow existing portfolio companies to operate under the original terms. This would be a form of grandfather rights.
However, it's important to note that grandfather clauses must be written into contracts or explicitly provided by regulation, they are not automatic. Additionally, there might be restrictions or conditions attached to the maintenance of these rights, and in some cases, grandfather rights may eventually expire after a certain period of time or under certain conditions.
Gross margin is a key financial metric that represents the proportion of each dollar of revenue that a company retains as gross profit. Gross profit is the income that a company makes from its sales after the cost of goods sold (COGS) is deducted.
The formula to calculate gross margin is:
Gross Margin = (Total Revenue - Cost of Goods Sold) / Total Revenue
The resulting figure is usually expressed as a percentage. For example, if a company's total revenue is $1,000,000 and its COGS is $400,000, its gross margin would be 60%. This means that for each dollar in revenue generated, the company keeps $0.60 after direct costs are accounted for.
Gross margin is an important indicator of a company's financial health. It shows how efficiently a company uses its resources — raw materials, labor, and manufacturing facilities — in the production process.
In the context of venture capital, gross margin is one of the key factors considered when assessing the financial health and potential profitability of a startup. A company with high gross margins might be more attractive to investors because it indicates the company has strong pricing power and/or cost controls. However, it's just one of many factors considered in investment decisions and should be considered alongside other financial metrics and qualitative factors.
Growth equity, sometimes referred to as growth capital, is a type of private equity investment focused primarily on mature companies that are looking for capital to expand or restructure operations, enter new markets, or finance a significant acquisition without changing control of the business.
Growth equity investments sit between venture capital and leveraged buyouts on the risk/return spectrum. Unlike venture capital, growth equity is typically invested in companies that are already profitable or have a clear path to profitability, and unlike leveraged buyouts, growth equity investments do not use significant amounts of leverage (borrowed money) to finance the investment.
Investors, often private equity firms or growth equity funds, expect a return on their investment in the form of capital appreciation over time. This can be achieved through improving operations, entering new markets, or developing new products or services.
The exit strategy for growth equity investments can include an initial public offering (IPO), a strategic acquisition, or a buyback of shares by the company's management.
While growth equity involves a lower risk compared to venture capital, it also usually involves potentially lower returns, as the companies involved are often not targeting the extremely high growth rates of early-stage startups.
Information rights are rights granted to investors, allowing them to receive regular updates about the financial condition and operational status of a company they have invested in. These updates might include quarterly financial statements, annual reports, budgets, or other relevant information.
Information rights are typically outlined in an investment agreement, such as a term sheet, and they can vary widely depending on the specific agreement and the nature of the investment. For example, an investor might have the right to receive monthly financial updates, be notified of any major changes in company strategy, or receive information about any significant corporate events such as a merger, acquisition, or major new contract.
In the venture capital context, information rights are important for maintaining transparency between a company and its investors. They allow investors to monitor their investment, track the company's progress, and make informed decisions about any future investments in the company.
However, it's also important for companies to manage these rights carefully, to ensure that sensitive information is protected and that the company complies with any relevant privacy laws or regulations.
An inside round is a round of financing where all the investment comes from existing investors, rather than including new investors.
This term is often used in the venture capital and private equity context. An inside round can occur for a variety of reasons. It may happen because the company is performing well and existing investors want to increase their stake. Alternatively, it can also occur when a company is unable to attract new investors, possibly due to poor performance or difficult market conditions, and relies on existing investors for additional funding.
While inside rounds can be a sign of confidence from existing investors, they can also sometimes be seen as a negative signal to the market, especially if it's perceived that the company was unable to attract new investors.
As with all investment decisions, the interpretation and implications of an inside round can depend heavily on the specific circumstances of the company and the broader market context.
An initial public offering (IPO) is the process by which a private company becomes publicly traded on a stock exchange. In an IPO, the company issues shares to public investors for the first time.
The primary purposes of an IPO are to raise capital, to provide liquidity for the investors and employees through a public market for the shares, and to enhance the company's public image and visibility in the marketplace.
The IPO process involves a number of steps:
Selection of Investment Bank(s): The company selects one or more investment banks to underwrite the IPO. The lead underwriter, often called the "book runner," works with the company to manage the IPO process.
Due Diligence and Regulatory Filings: The underwriter conducts due diligence to verify the company's financial information. The company then files a registration statement, including a prospectus, with the Securities and Exchange Commission (SEC). The prospectus provides detailed information about the company's business, financials, and the planned use of the capital raised.
Pricing: The underwriter and the company decide on the price at which the shares will be issued. This involves assessing market conditions, investor demand, and the company's financials and prospects.
Marketing: The underwriter and company conduct a "road show" to market the offering to potential investors. The goal is to generate interest and demand for the shares.
Going Public: The shares are issued to investors and begin trading on a stock exchange. After the IPO, the company is subject to increased regulatory scrutiny and must regularly file financial reports with the SEC.
In the context of venture capital, an IPO is often viewed as a successful exit strategy as it can provide significant returns for early-stage investors. However, it also brings new challenges, including increased regulatory requirements and pressure to meet the market's quarterly earnings expectations.
The internal rate of return (IRR) is a financial metric that is widely used in capital budgeting and investment planning. IRR provides an estimate of the profitability of potential investments. It is the discount rate that makes the net present value (NPV) of a series of cash flows equal to zero.
Mathematically, the IRR is defined as any discount rate that results in a net present value of zero, and it's calculated using the following formula:
0 = NPV = ∑ [Ct / (1+IRR)^t] - C0
Where:
Ct is the net cash inflow during the period t
C0 is the total initial investment costs
t is the number of time periods
In simpler terms, IRR can be considered as the interest rate at which the investment breaks even in terms of NPV.
In the context of venture capital and private equity, IRR is often used as a measure of the annual return generated by an investment. Since these investments involve multiple cash flows at different periods (such as initial investment, follow-on investments, and proceeds from an exit), the IRR provides a single, time-weighted return figure that can be used to compare different investment opportunities.
However, it's important to note that while IRR can be a useful tool, it has its limitations. For instance, it assumes that all cash flows can be reinvested at the IRR rate, which may not always be feasible in reality. Additionally, it may not provide a useful measure when comparing investments of different durations.
Investment banking is a specific division of banking related to the creation of capital for other companies, governments, and other entities. Investment banks underwrite new debt and equity securities for all types of corporations, aid in the sale of securities, and help to facilitate mergers and acquisitions, reorganizations, and broker trades for both institutions and private investors. They may also provide guidance to issuers regarding the issue and placement of stock.
Investment banks differ from commercial banks, which take deposits and make loans. Investment banks focus on investment and capital-raising strategies for corporations and governments. Some of the key functions of investment banking include:
Underwriting: This involves the process of raising capital for companies by issuing securities, either debt or equity.
Mergers and Acquisitions: Investment banks advise companies on the process of merging with other companies or acquiring other companies.
Sales and Trading and Equity Research: Investment banks connect buyers and sellers in the financial markets, providing liquidity for investors. They also conduct equity research to aid investors in their decisions to buy, sell, or hold certain securities.
Restructuring: They assist companies in restructuring their capital or operations to improve their financial health.
Asset Management: Some investment banks also offer wealth and asset management services for individuals and institutions.
Examples of some of the world's largest investment banks include Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Bank of America Merrill Lynch.
In the venture capital context, investment banks can play a critical role in helping startups go public through an initial public offering (IPO), facilitating mergers and acquisitions, or raising additional capital.
An investor is an individual or organization that allocates capital with the expectation of a future financial return. Investors typically undertake this action in order to grow their wealth and/or provide for future financial needs, such as retirement or other long-term goals.
There are different types of investors, including:
Retail or Individual Investors: These are individual investors who invest their personal capital into a wide range of securities.
Institutional Investors: These are organizations such as banks, pension funds, mutual funds, and insurance companies that invest large sums on behalf of their clients or as part of their own investment strategies.
Angel Investors: These are high-net-worth individuals who provide capital for startups, often in exchange for ownership equity or convertible debt. Angel investors can provide valuable resources and guidance to startups in addition to their capital.
Venture Capitalists: These are investors who provide capital to startups or young companies that have the potential for long-term growth. Venture capitalists usually provide this funding in exchange for equity, and often contribute their expertise and business networks to help the company grow.
Private Equity Investors: These are investors or investment firms that provide capital to companies that are not publicly traded. They often aim to acquire controlling interests and may seek to restructure the company to improve its financial performance and eventually sell it at a profit.
Different types of investors tend to have different risk tolerances, time horizons, and strategies, and they play different roles in the economy and in the capital markets.
The Jumpstart Our Business Startups Act, or JOBS Act, is a law that was signed into effect by President Barack Obama in 2012. The primary aim of the JOBS Act is to encourage the funding of small businesses in the United States by easing various securities regulations.
Key provisions of the JOBS Act include:
Title II – Access to Capital for Job Creators: This provision lifted the ban on general solicitation or advertising for certain types of private securities offerings. Companies can now publicly advertise that they are seeking investments, opening up a larger pool of potential investors.
Title III – Crowdfunding: This provision provides a regulatory structure for startups and small businesses to raise capital through securities offerings via crowdfunding. It sets a limit on the amount an individual can invest in a 12-month period, based on their income and net worth.
Title IV – Small Company Capital Formation (Regulation A+): This provision updated and expanded Regulation A, creating a new category (Regulation A+) that allows private companies to raise up to $50 million from the public, subject to SEC review and regulations.
Title V and VI – Private Company Flexibility and Growth and Capital Expansion: These provisions increased the number of shareholders a company can have before it must register its common stock with the SEC and become a publicly reporting company.
Title I – Reopening American Capital Markets to Emerging Growth Companies: This provision created a new category of issuers, "emerging growth companies" (EGCs), that have under $1 billion in annual revenue. EGCs are subject to fewer regulatory and disclosure requirements when they go public, which can make the IPO process less costly.
These changes significantly impacted the landscape for startup financing, including venture capital, by creating new pathways for companies to raise funds and ultimately aim to stimulate economic growth by making it easier for startups and small businesses to access capital.
A key man clause is a contractual provision that requires certain executive(s) or significant personnel (the "key men" or "key women") to be actively involved in a company for the duration of the agreement.
The purpose of a key man clause is to mitigate risks associated with the potential loss of key individuals who are critical to the performance and success of a business. For instance, these might be founders, top executives, or other significant contributors without whom the business might suffer substantial harm.
In a venture capital or private equity context, a key man clause can be part of a fund's limited partnership agreement. It might stipulate that certain individuals (such as the fund's top managers or partners) must remain actively involved in the fund's operations. If those individuals cease to be involved (e.g., due to resignation, retirement, prolonged illness, etc.), the key man clause might trigger certain protections, such as suspending the fund's investment period or giving limited partners the right to end the fund's existence.
This clause serves to protect the interests of investors, who often make investment decisions based on the presence and involvement of specific individuals within a company or a fund.
A lead investor, also known as an anchor investor, is an individual or organization that organizes and leads a round of investment in a company, typically a startup. This investor usually contributes the largest amount of capital in the investment round and plays a key role in arranging the terms of the investment.
The lead investor's role often includes:
Due Diligence: The lead investor often conducts the primary due diligence on the company, assessing its business model, market, financials, and team. The findings are then usually shared with other potential investors.
Setting Terms: The lead investor typically sets the terms of the investment round, including the valuation of the company, the structure of the deal, and the form of the investment (equity, convertible note, etc.).
Syndicate Formation: The lead investor often helps to form a syndicate of other investors who will participate in the round. This can include reaching out to other potential investors, sharing due diligence findings, and advocating for the investment.
Post-Investment: After the investment, the lead investor often takes a seat on the company's board of directors and plays an active role in guiding the company. They may assist with strategy, governance, and further fundraising rounds.
In the context of venture capital, having a reputable lead investor can be a significant advantage for a startup, as it can help attract other investors and lend credibility to the company.
Lifetime value (LTV), also known as customer lifetime value (CLTV), is a prediction of the net profit attributed to the entire future relationship with a customer. It is an important metric in business and marketing, as it helps a company understand how much revenue they can expect one customer to generate over the course of the business relationship.
The longer a customer continues to purchase from a company, the greater their lifetime value becomes. LTV helps companies frame their understanding of customer acquisition costs and customer retention strategies.
The simplest form of LTV is calculated as follows:
LTV = Average Purchase Value x Average Purchase Frequency x Average Customer Lifespan
Where:
Average Purchase Value refers to the average dollar amount spent each time a customer makes a purchase.
Average Purchase Frequency represents how often customers come back to make another purchase.
Average Customer Lifespan is the average number of years a customer continues buying from your company.
In the context of startups and venture capital, understanding LTV is important for both the companies themselves and for potential investors. It helps companies determine appropriate spending on customer acquisition and retention, and it helps investors evaluate the potential long-term revenue of a company.
However, LTV is a prediction, which means it comes with a degree of uncertainty, especially for new companies without much historical data. Companies and investors must therefore use and interpret LTV with caution.
A Limited Partner (LP) is an investor in a limited partnership, which is a type of legal business structure. Limited partnerships typically consist of one or more general partners (GPs) and one or more limited partners.
The role of a limited partner is mainly financial, providing capital to the partnership. Limited partners share in the profits of the business, but their losses are limited to the extent of their investment. They do not typically engage in the day-to-day operations or management decisions of the partnership, which are responsibilities of the general partners.
In the context of venture capital and private equity funds, the limited partners are typically institutional investors like pension funds, endowments, insurance companies, and high-net-worth individuals, while the general partners are the managers of the fund. Limited partners in a venture capital fund provide the capital that the general partners use to make investments in startups and other high-potential companies.
The structure of a limited partnership provides LPs with a level of liability protection. If the partnership fails or incurs debts, the limited partners are generally only liable up to the amount they have invested in the partnership, protecting their personal assets outside of the investment. This is one of the reasons why the limited partnership structure is commonly used for investment vehicles like venture capital and private equity funds.
Liquidation, in a financial and business context, is the process of bringing a business to an end and distributing its assets to claimants, which is done when a company is insolvent or does not have the resources to meet its financial obligations. The process is usually overseen by a liquidator who sells the company's tangible and intangible property and uses the proceeds to pay off the company's debts.
After the sale of all assets and the payment of all liabilities, the remaining cash is distributed to shareholders. This distribution is conducted based on the priority of claims, with secured creditors, unsecured creditors, and owners of preference shares typically receiving distributions before the owners of common shares.
In a venture capital context, a liquidation event is typically the sale of a portfolio company (via merger, acquisition, or Initial Public Offering) or its closure. The term is also used in "liquidation preference," a term in a venture capital contract that specifies who gets paid first and how much they get paid in the event of a liquidation.
Liquidation preference is an important aspect for venture capital investors because it provides them with a measure of protection for their investment. For example, it's common in venture capital deals for investors to have a "1X liquidation preference," which means that in a liquidation event, they are entitled to receive back their invested capital before the holders of common stock (usually the founders and employees) receive anything.
Liquidation preference is a clause in a contract that determines the payout order in case of a corporate liquidation. This is particularly relevant in venture capital and private equity, where investments are typically made in the form of preferred shares, which come with a set of rights and privileges not enjoyed by common shareholders.
The liquidation preference essentially determines who gets paid first and how much they get paid when a liquidity event, like the sale of the company (through a merger, acquisition, or IPO), or its liquidation, occurs. The remaining proceeds, if any, are then distributed to the holders of common stock.
For example, if an investor has a "1X liquidation preference", they are entitled to receive back their invested capital before any proceeds from the sale or liquidation are distributed to the holders of common stock (usually the founders and employees). If there is money left over after the preferred shareholders are paid, it is then distributed to the common shareholders according to their ownership percentage.
This preference provides a measure of downside protection for investors. In some cases, a liquidation preference may be "participating", meaning that after receiving their initial amount, the investor also participates in the distribution of the remaining assets with the common shareholders.
It's important to note that while liquidation preferences can protect investors, they can also reduce the amount of money common shareholders receive in a liquidity event, particularly if the company is sold for a low price. Therefore, the specifics of liquidation preferences can often be a point of negotiation in investment deals.
A liquidity event is an occurrence that allows a company's owners and investors to cash out or liquidate their ownership stakes, turning their investment into cash or an asset that can be quickly converted into cash.
For startups and their investors, common types of liquidity events include:
Initial Public Offering (IPO): This is when a company offers its shares to the public on a stock exchange for the first time. An IPO can provide liquidity to the company's investors, as they can sell their shares on the open market after the company goes public.
Sale of the Company (Acquisition/Merger): If a company is sold to another company, or merges with another company, the owners and investors typically receive cash, stock in the acquiring company, or a combination of both, thereby liquidating their investment.
Buyout: This involves investors or other companies buying the stakes of a company's owners or other investors, providing them with liquidity.
Secondary Sale: In a secondary sale, investors sell their shares to other investors, which allows the original investor to achieve liquidity without the company needing to be sold or go public.
Recapitalization: In this event, the company issues new stock or debt, and the proceeds are used to buy out the original investors.
For venture capitalists and other investors in startups, the goal is typically to invest in a company, grow the value of the company, and then have a liquidity event where they can sell their shares for a substantial profit. The process from initial investment to liquidity event can take many years, and not all startups will reach a liquidity event.
A lock-up period, in the context of startups and venture capital, is a predetermined length of time following an initial public offering (IPO) during which the company's insiders and early investors are not allowed to sell their shares.
Lock-up periods typically last 90 to 180 days, but the exact duration can vary depending on the specific agreement. The purpose of this period is to prevent the market from being flooded with a large number of shares all at once, which could devalue the company's stock.
The lock-up period allows the market to absorb the IPO's share supply gradually, helping to stabilize the stock price in the early months of trading. This provides the public market some level of assurance that early investors and insiders will not immediately sell their shares, potentially causing a sharp drop in the stock price.
Once the lock-up period ends, insiders and early investors are free to sell their shares, which can sometimes lead to increased volatility in the company's stock price if a significant number of those shares are sold off.
Lock-up periods are required by most underwriting firms before agreeing to an IPO and are enforced via contractual agreements between the company going public and its pre-IPO shareholders.
A Limited Partner Agreement (LPA) is a contract that details the legal structure, rights, obligations, and financial terms between the general partners (GPs) and limited partners (LPs) of a limited partnership.
In the context of venture capital (VC) and private equity (PE) firms, the limited partnership is often the structure used to create the investment fund. The general partners manage the fund and make investment decisions, while the limited partners are usually outside investors that provide the capital but do not participate in the management of the fund.
Key terms outlined in a Limited Partner Agreement typically include:
Commitment: The amount of capital each LP commits to the fund.
Capital Calls: The process and timeline by which LPs must provide their committed capital to the fund.
Management Fees: Fees that LPs pay to the GPs for managing the fund.
Carried Interest: The share of the fund's profits that go to the GPs, typically around 20%.
Investment Strategy: Description of the types of investments the fund will make.
Term of the Fund: The lifespan of the fund, which includes the investment period and the divestment period.
LPs' Rights: Including rights to information about the fund's performance and activities, and voting rights on certain fundamental changes to the fund.
Exit Provisions: Conditions under which the partnership may be terminated or dissolved.
Dispute Resolution: Mechanisms for resolving disputes between the LPs and GPs.
The LPA is an essential document as it governs the relationship between LPs and GPs, and it is usually heavily negotiated before an LP commits capital to a fund. As these agreements are legally binding, it is crucial that all parties fully understand their rights and obligations under the agreement.
A managing partner is an individual who has management authority in a partnership organization structure, such as a law firm, accounting firm, consulting firm, or investment firm (including venture capital and private equity firms). This role is akin to the CEO of a corporation.
In the context of venture capital (VC) and private equity (PE) firms, a managing partner is typically one of the senior-most roles and is responsible for the overall strategy and management of the firm. This may involve setting the firm's investment strategy, making final investment decisions, overseeing the firm's portfolio of investments, and managing relationships with limited partners (the investors in the VC or PE fund) and the management teams of portfolio companies.
The specific responsibilities of a managing partner can vary widely, as they are determined by the partnership agreement and the unique dynamics of the firm. In some firms, there might be several managing partners who share management responsibilities.
Importantly, a managing partner also often contributes personal funds to the investment fund, aligning their interests with those of the limited partners. They typically earn a management fee as well as a share of the profits from the firm's investments (known as "carried interest").
A management fee is a charge levied by an investment manager for managing an investment fund. The fee is meant to cover the operational expenses of the manager, including overhead costs, salaries, research, reporting, and client service.
In the context of venture capital and private equity, the management fee is usually a percentage of the fund's committed capital or invested capital, typically ranging between 1% and 2.5% annually. It's often set on a sliding scale – higher in the early years of the fund when more active investment is taking place, and lower in later years.
For example, a venture capital firm may charge a 2% management fee on a $100 million fund, which would result in a $2 million per year fee. This fee is paid to the firm regardless of the fund's performance and is meant to cover the firm's operating costs.
It's important to note that the management fee is separate from the "carried interest," which is a share of the fund's profits that the managers receive if the fund is successful.
A Memorandum of Understanding (MoU) is a type of agreement between two or more parties that outlines the terms and details of an understanding, including each parties' requirements and responsibilities. An MoU is often used to establish official partnerships and is less formal and legally binding than a contract.
However, like a formal contract, an MoU can be used to clearly define the roles and responsibilities of each party, ensuring everyone is on the same page and working towards the same goals. An MoU can cover a wide range of subjects, including project outlines, partnership goals, and details about resources, timing, and implementation.
In a venture capital context, an MoU might be used in the early stages of a deal to define the basic terms of an investment agreement before a more formal, legally binding contract is drafted and signed. It can also be used as a form of non-binding agreement between a startup and a corporate partner, outlining their intent to collaborate on a specific project or initiative.
Despite not usually being legally binding, an MoU should still be approached with caution and care, as it can carry significant moral and reputational weight, and in some cases, certain aspects of it may be considered legally enforceable depending on the jurisdiction and the specific wording of the document.
Mezzanine financing is a hybrid form of capital that blends aspects of debt financing and equity financing. It's often used by companies that are looking for capital for expansion or to finance an acquisition but want to avoid diluting existing shareholders by issuing more common equity.
In the capital structure of a company, mezzanine financing is subordinated to senior debt (like bank loans) but ranks above common equity. This means that if the company were to be liquidated, mezzanine debt holders would be paid out after senior debt holders but before equity holders.
Mezzanine financing typically takes the form of subordinated debt or preferred equity and often includes an equity-based option, such as warrants or conversion rights, which allow the lender to convert their interest into equity. This structure provides the lender with the safety of a fixed income instrument (through interest payments), but also the potential upside of an equity stake in the company.
The interest rate on mezzanine financing is usually higher than that of traditional bank loans due to its higher risk position in the capital structure, but lower than the potential returns expected from equity investments.
In the context of venture capital and private equity, mezzanine financing is often used in leveraged buyouts and growth capital situations, typically for more mature companies with steady cash flows that can service the debt portion of the financing. It can be a critical source of funding for companies that are too large for venture capital but not quite large enough for traditional corporate bond or stock offerings.
A Micro Venture Capital (Micro VC) firm is a type of venture capital firm that typically manages smaller funds and makes smaller investments than traditional venture capital firms.
Micro VCs typically manage funds that are less than $100 million in size, and they often focus on early-stage or seed-stage investments, providing the initial capital that a startup needs to get off the ground. Individual investment amounts can vary, but they are usually significantly smaller than those made by larger VC firms, often in the range of $25,000 to $500,000.
Micro VC firms are often able to take on more risk than larger VC firms, as the smaller investment amounts allow them to build more diversified portfolios. They often focus on niche sectors or emerging industries, and may provide more hands-on guidance and support to their portfolio companies than larger VC firms.
The Micro VC landscape has grown significantly in the last decade, providing startups with more options for early-stage financing. For entrepreneurs, Micro VCs can offer a valuable source of capital and support, especially for those who are not yet ready or are not a fit for larger VC firms.
Monthly recurring revenue (MRR) is a metric used by companies with subscription-based business models to measure the total amount of predictable revenue they can expect on a monthly basis. This includes businesses that operate on a Software-as-a-Service (SaaS) model, subscription box services, media subscriptions, and more.
MRR is calculated by multiplying the total number of paying customers by the average revenue per user (ARPU). For instance, if a company has 1,000 customers paying $50 each month, its MRR would be $50,000.
MRR is a key performance indicator (KPI) for subscription businesses as it provides insight into revenue trends and growth rates, and can assist with cash flow forecasting. By tracking changes in MRR, companies can gain insights into how changes in pricing, marketing efforts, or product updates affect revenue.
There are different types of MRR:
New MRR: Revenue from new customers acquired during a specific period.
Expansion MRR: Additional revenue from existing customers due to upselling, cross-selling or upgrading their subscription plan.
Churned MRR: Lost revenue due to customers downgrading their plans or canceling their subscriptions.
Net New MRR: The sum of New MRR and Expansion MRR minus Churned MRR.
In the context of venture capital, investors often look at MRR to gauge the financial health and growth potential of a startup. Companies with high or rapidly-growing MRR may be seen as more attractive investments.
A "no shop" clause (also known as an exclusivity clause) is a provision often included in a letter of intent (LOI) or term sheet during acquisition or investment negotiations. This clause prohibits the company (seller or potential investee) from soliciting or entertaining offers from other potential buyers or investors for a specified period of time.
The purpose of a "no shop" clause is to protect the interested buyer or investor who is investing time and resources in due diligence. During the no-shop period, the potential buyer or investor has the exclusive right to continue negotiations, conduct due diligence, and potentially close the deal.
The exact duration of the no-shop period can vary, but it typically lasts for several weeks to a few months. The company is allowed to continue its normal business operations during this period, but it cannot seek or negotiate alternative offers.
In case the company breaches the no-shop clause, there may be penalties or consequences, as stipulated in the agreement. However, these clauses usually permit the company's board of directors to consider unsolicited offers if they have a fiduciary duty to do so.
Overall, the no-shop clause is a standard element in many negotiation scenarios, but its terms should be carefully reviewed and negotiated by both parties.
A non-disclosure agreement (NDA), also known as a confidentiality agreement, is a legal contract between two or more parties that outlines information that the parties wish to share with one another for certain purposes, but wish to restrict from wider use or dissemination.
The NDA sets out the terms and conditions that prohibit the receiving party from disclosing the sensitive and proprietary information covered by the agreement. This information often includes trade secrets, business strategies, customer lists, proprietary technology, product specifications, and other types of confidential information.
There are three types of NDAs:
Unilateral NDA: Only one party discloses information and the other party agrees not to disclose it. This is common when a company is revealing proprietary information to an individual or business, like an employee or contractor.
Bilateral NDA or Mutual NDA: Both parties disclose confidential information to each other and both agree to keep it secret. This type is common in discussions between two companies exploring a potential partnership or joint venture.
Multilateral NDA: More than two parties are involved, where at least one of the parties anticipates disclosing information to the others and requires that the information be protected.
In the context of venture capital and startups, NDAs are frequently used when a company is raising capital and needs to disclose sensitive information to potential investors for due diligence purposes.
It's important to note that while NDAs are legally binding documents, enforcing them can be challenging and potentially costly. Therefore, parties should be careful about what information they choose to disclose, even under an NDA.
Observer rights are rights given to an investor or a representative of an investor, allowing them to attend and observe the meetings of a company's board of directors, but without the right to vote on matters presented to the board. These rights are often given to significant investors who do not have a seat on the board.
The intention behind observer rights is to allow the investor to monitor their investment closely and to stay informed about the company's operations, strategy, and financial situation. However, an observer does not have the same power or responsibilities as a director.
Observer rights are typically outlined in the investment documents, such as the shareholders' agreement or the investors' rights agreement, and may include the right to receive the same information as board members, including financial statements and board meeting minutes.
It's important to note that while observer rights can be a valuable tool for investors, companies often limit these rights to prevent having too many observers in board meetings, which can lead to logistical challenges and inhibit open discussion among board members. In addition, some matters may be discussed in "executive sessions" where observers are not permitted.
As with all terms in an investment agreement, observer rights should be negotiated and carefully considered by both parties.
An operating agreement is a legal document that outlines the ownership structure and member roles of a Limited Liability Company (LLC). This agreement typically provides a detailed outline of various business procedures and aspects, effectively guiding the operations of the company.
The operating agreement often includes information such as:
The ownership percentages among members.
The method for distributing profits and losses.
The responsibilities and roles of members and managers.
Procedures for making decisions and resolving disputes.
Guidelines for adding or removing members.
Processes for dissolving the company.
While an operating agreement is not required by law in every state, it's strongly recommended for every LLC, regardless of its size, as it provides clear rules and procedures for the business and can help avoid disputes between members. It also provides an opportunity to establish rules that are tailored to the needs of the business, rather than defaulting to the general state laws.
In the context of venture capital, the operating agreement can be a critical document when an investment is being made in an LLC. The agreement can provide important information about the company's structure and operations, and may be negotiated as part of the investment process. However, most venture capital investments are made in corporations, not LLCs, due to various legal and structural advantages.
An option pool refers to a block of company equity that is set aside for future issuance to employees, consultants, advisors, and directors. It's often used as an incentive to attract, retain, and motivate key personnel and align their interests with those of the company and its shareholders.
In the context of a startup, an option pool is typically created as part of a financing round and can range between 10% and 20% of the total outstanding equity, although this can vary widely depending on the company's stage and specific needs.
An option from this pool gives the holder the right, but not the obligation, to buy a certain amount of equity in the company at a pre-set price, known as the exercise price. The option usually becomes valuable and can be exercised when the company's stock price rises above the exercise price, providing a financial benefit to the holder.
Options generally vest over a certain period of time, meaning they become exercisable in increments over the vesting period (often four years). This vesting schedule incentivizes employees to stay with the company for a longer period.
In venture capital negotiations, the size of the option pool can affect the company's pre-money valuation because the option pool is usually included in the pre-money valuation and therefore dilutes existing shareholders, including founders. Hence, the option pool is often a topic of discussion and negotiation in financing rounds.
An over-allotment option (also known as greenshoe option) is a provision commonly included in an underwriting agreement of an initial public offering (IPO). This option allows the underwriters (typically investment banks) to issue up to an additional 15% of company shares at the offering price.
The over-allotment option provides two primary benefits:
Stabilization of share price: If the demand for shares exceeds the original number of shares offered, the underwriters can exercise the over-allotment option to meet the excess demand, which can help stabilize the share price in the open market.
Additional capital for the company: If the share price increases post-IPO and there is sustained demand, exercising the over-allotment option allows the company to raise additional capital beyond the original IPO size.
The term "greenshoe" comes from the Green Shoe Manufacturing Company (now known as Stride Rite Corporation), which was the first to grant such an option to its underwriters in its IPO in 1919.
It's important to note that the decision to exercise the over-allotment option lies solely with the underwriters, not the company going public, and it is usually exercised within 30 days of the IPO if the share price trades above the offering price. If the share price falls below the offering price, the underwriters would not exercise the option as they would incur losses by selling shares at the lower market price.
Participating preferred stock is a type of preferred stock that gives the holder the right to receive dividends (or other distributions) equal to the generally stated preference amount and also an additional amount relating to the number of common shares into which the preferred stock could be converted.
In the context of venture capital, when a startup company is sold (either through a sale of the company or an IPO), the holders of participating preferred stock typically have the right to get their initial investment back (often with some accrued dividends), and then also share in the remaining proceeds on an as-converted-to-common basis with the common stockholders.
This is also called having a "liquidation preference plus participation" and can result in the holders of participating preferred stock receiving a larger portion of the sale proceeds than common shareholders (including the founders and employees).
The specific terms of participating preferred stock can vary widely, so it's important for entrepreneurs and investors to understand these terms when negotiating an investment. In some cases, there may be a cap or multiple on the participation feature, limiting the total amount that participating preferred shareholders can receive.
There's often a tradeoff between participating preferred stock and the price of the round. For instance, investors might agree to a higher valuation if they get participating preferred stock, or alternatively, entrepreneurs might agree to participating preferred stock in return for a higher valuation. However, the use of participation features in venture capital deals can be controversial, as some view it as potentially being unfavorable to the entrepreneurs and employees.
"Pay to play" is a provision often included in venture capital financing agreements, which requires investors to participate in future financing rounds in order to avoid having their preferred stock converted into common stock or a less senior class of preferred stock.
The objective of this provision is to motivate current investors to continue supporting the company in future financing rounds. It is particularly used in situations where the company might face difficulties in raising funds or in "down rounds" where the company's valuation has decreased since the last financing round.
If investors do not "pay to play" (i.e., they do not participate in the subsequent financing round), they face certain penalties, the most severe of which is typically the automatic conversion of their preferred shares into common shares. Since preferred shares generally have more rights and benefits attached to them than common shares, this conversion can be a significant downside for the investor.
Pay to play provisions can ensure ongoing support from existing investors and potentially make it easier to attract new investors, as they see the commitment from existing investors. However, they can also be seen as burdensome or unfair to smaller investors who may not have the financial capacity to participate in every round of financing.
As always, the specific terms and conditions of pay to play provisions can vary widely and are subject to negotiation between the company and its investors.
Piggyback registration rights are a type of registration rights that give an investor the right to register and sell their shares when the company or another investor initiates a registration. Essentially, they "piggyback" on another registration statement filed by the company.
For example, if a company decides to go public (Initial Public Offering or IPO) or if the company files a registration statement for a public offering of its securities on behalf of another investor who has demand registration rights, the holders of piggyback registration rights can include their shares in the offering.
Piggyback registration rights are considered less potent than demand registration rights, which allow investors to force the company to register their shares under certain conditions. However, piggyback registration rights are commonly included in investment agreements, as they provide a way for investors to achieve liquidity for their shares when the company goes public or registers shares for other investors.
However, underwriters of a public offering have the discretion to limit the number of shares included in the offering for a variety of reasons, such as concerns about diluting the market. In these situations, the offering may not include all shares held by piggyback rights holders. The allocation of shares in such cases is usually done based on negotiated provisions in the investors' agreements.
As with all terms in an investment agreement, piggyback registration rights should be carefully negotiated and considered by both the company and its investors.
A portfolio company is a company that is owned partially or wholly by an investment firm, such as a private equity firm, venture capital firm, or hedge fund. These firms make investments in companies with the intent of growing the business and, eventually, realizing a return on investment through an exit event like a sale or an IPO (Initial Public Offering).
Investment firms typically hold a variety of investments in different companies across different sectors or industries, creating a "portfolio" of investments. Each individual company within this portfolio is referred to as a "portfolio company".
Investors actively manage their portfolio companies with the aim to increase their value. They may provide strategic guidance, operational support, industry expertise, and other resources to help the company scale. The specific level of involvement can vary widely, depending on the investment firm's strategy and the nature of the investment.
Portfolio companies represent the investment firm's active investments, and the performance of these companies has a direct impact on the performance of the investment firm itself. Therefore, these firms have a vested interest in the success of their portfolio companies.
Post-money valuation is a company's estimated worth after outside financing and capital injections are added to its balance sheet. It includes the value of a recent round of funding, which can be used to hire new talent, develop new products or services, or further fuel expansion.
The post-money valuation is calculated as follows:
Post-money valuation = Pre-money valuation + Newly invested capital
This concept is used in venture capital and private equity financing. The distinction between pre-money and post-money valuation lies in the timing of when a round of financing is factored into a company's valuation.
For example, if a startup has a pre-money valuation of $10 million and then it receives $2 million in a round of venture capital financing, the post-money valuation becomes $12 million.
This valuation is important as it determines the equity stake given away to investors. If a company is valued at $10 million (pre-money) and an investor commits to invest $2 million, the investor would receive a 16.67% stake based on the post-money valuation of $12 million.
It's crucial for entrepreneurs to understand the difference between pre-money and post-money valuation, as it directly impacts how much equity they retain in their company after a funding round.
Post-seed, also known as seed extension, seed plus, or seed 2, is a financing round that comes after the initial seed funding but before the Series A round. The post-seed round provides additional capital to startups that have already used their seed capital but need more funding to hit the milestones necessary for a Series A round, typically due to the increased competition and higher expectations from investors in the Series A stage.
In recent years, the landscape of startup funding has changed. Previously, the path from seed to Series A was more direct. Startups would raise a seed round, use this capital to develop their product or service, and then raise a Series A round for market expansion.
However, with the growth of the startup ecosystem, Series A investors have started looking for more advanced key performance indicators (KPIs), such as significant user growth, product/market fit, or substantial revenue generation, before they invest. As a result, startups often need more capital than what was raised in the seed round to achieve these milestones. This is where the post-seed round comes in.
The post-seed round provides startups with the additional runway they need to meet the higher expectations of Series A investors. However, this round should not be taken lightly as raising a post-seed round can imply that the company was not able to achieve the expected milestones with its seed funding, which might raise red flags for future investors.
As always, the specific circumstances and needs of the startup will dictate whether a post-seed round is necessary or advantageous.
Preferred shares (also known as preferred stock) are a class of shares in a company that have a higher claim on the assets and earnings than common stock. Preferred shares typically come with a fixed dividend that must be paid out before dividends to common shareholders.
In the context of venture capital (VC) financing, preferred shares are often issued to investors and come with additional rights not usually afforded to common shareholders, such as:
Liquidation Preference: This means that in the event of a liquidation or sale of the company, preferred shareholders get paid out before common shareholders. This reduces the risk for the VC investors. The specific terms of the liquidation preference can vary (e.g., 1x, 2x, etc.), but it generally ensures that the VC investors get at least their initial investment back.
Conversion Rights: Preferred shares often come with the ability to convert to common stock at the discretion of the holder. This can be advantageous if the company does well and the value of the common stock exceeds the value of the preferred stock plus any dividends.
Voting Rights: Preferred shareholders may have greater voting rights on certain issues or may have veto rights on specific company decisions.
Dividends: Preferred stock often carries a dividend that is paid out before any dividends are paid to common stockholders.
Anti-Dilution Protection: In the event the company issues additional shares in the future at a lower price, the preferred shareholders may have their shares repriced to this lower price to avoid dilution.
The exact terms and rights of preferred shares can vary significantly and are typically negotiated between the company and the investors during the financing process.
Pre-money valuation is the valuation of a company immediately before it goes through a round of financing or receives new investment, which will inevitably dilute the ownership percentages of existing shareholders. It is used by venture capitalists, private equity investors, and other investors to determine the amount of equity they will receive in exchange for their investment.
For instance, if a company is said to have a pre-money valuation of $5 million, and an investor is planning to inject $1 million into the company, the investor would be buying 16.67% of the company, calculated as follows: $1 million (investment) / $6 million (post-money valuation, which is pre-money valuation + new investment).
It's worth noting that a company's pre-money valuation is largely subjective and is typically negotiated between the company and potential investors based on various factors such as market conditions, the company's current financial health, the company's growth prospects, and comparable valuations for similar companies.
Understanding pre-money valuation is crucial for both founders and investors as it directly impacts the dilution of existing shares and the ownership structure of the company post-investment.
In the context of finance and investing, "principal" can have a couple of different meanings:
Loan or Investment Principal: This refers to the original sum of money that is borrowed or invested before interest, dividends, profits, or any other returns are calculated. For example, if an investor provides a company with a $1 million loan, the principal amount is $1 million. Similarly, if an investor puts $500,000 into a startup as equity financing, the principal amount of the investment is $500,000.
Principal in a Firm: In this context, "principal" refers to an individual who has a key leadership position or ownership stake in an investment firm or similar business. In a venture capital or private equity firm, for example, principals are typically one level below the partners and are involved in identifying potential investment opportunities, executing deals, and managing portfolio companies. The specific responsibilities of a principal can vary widely from firm to firm and may also change over time.
In the context of a venture capital glossary, you're probably referring to the second definition, where a principal is a role within an investment firm. However, it's always important to consider the context to understand which definition is being used.
Protective provisions are specific rights given to preferred shareholders in a company, typically in venture capital and private equity transactions. These provisions can vary widely but generally serve to protect the investor's investment and grant them certain powers over the management and strategic direction of the company.
Common protective provisions may include:
Liquidation Preference: This ensures that preferred shareholders receive their investment back before any proceeds are distributed to common shareholders in the event of a liquidation event, such as a sale or merger.
Veto Rights: These allow preferred shareholders to veto or approve certain actions by the company, such as issuing new securities, changing the company's bylaws, or initiating a merger or sale.
Board Representation: Preferred shareholders may have the right to designate a certain number of directors on the company's board.
Anti-Dilution Provisions: These protect the investor's ownership percentage from being diluted in future funding rounds.
Dividend Rights: Some preferred shareholders have a right to receive dividends before they are distributed to common shareholders.
Conversion Rights: These allow preferred shares to be converted into common shares, usually at the discretion of the shareholder.
Redemption Rights: In some cases, preferred shareholders have the right to sell their shares back to the company after a certain period.
Protective provisions are negotiated during the financing process and are typically included in a company's articles of incorporation or in a separate investor rights agreement. Both the company and the investor need to carefully consider and negotiate these provisions, as they can significantly impact the company's governance and the investor's potential return on investment.
Pro-rata rights, also known as pre-emptive rights, are a clause in an investment agreement that allows investors to maintain their percentage ownership in a company when the company issues more shares.
In the context of venture capital, when a company decides to raise more capital by issuing new shares (in a subsequent funding round, for example), existing shareholders may experience dilution of their ownership stake. Pro-rata rights give these shareholders the option, but not the obligation, to participate in the new funding round to maintain their original ownership percentage.
For example, if an investor owns 10% of a company and the company decides to raise more capital and issues new shares, that investor's stake could be diluted. However, if the investor has pro-rata rights, they have the option to purchase enough of the newly issued shares to maintain their 10% ownership stake.
These rights are often sought by venture capitalists and other early-stage investors as they allow the investor to maintain their percentage ownership as the company grows and raises more capital. This could be especially valuable if the company is performing well and its value is increasing.
Note that pro-rata rights may not always be granted and are usually a point of negotiation between the company and its investors. Some smaller or less influential investors may not be able to negotiate for these rights, or the company may limit these rights to avoid having to accommodate a large number of investors in future rounds.
A Qualified Initial Public Offering (IPO) refers to an IPO that meets certain predetermined criteria as outlined in the legal agreements between a company and its investors. These criteria may include a minimum offering size, a minimum share price, or a minimum company valuation at the time of the IPO.
The criteria for what constitutes a Qualified IPO are generally established during financing negotiations, often at the time of a venture capital investment. They are typically designed to ensure that an IPO meets the investors' expectations in terms of providing a sufficient return on their investment.
In some cases, certain investor rights or company obligations may be triggered or terminated upon a Qualified IPO. For instance, some preferred stock might automatically convert to common stock upon a Qualified IPO. Or, certain protective provisions granted to investors may expire upon a Qualified IPO.
These provisions can vary widely, and the specific terms are typically laid out in a company's investment or shareholders' agreement. As such, it's always important to understand the specifics of what constitutes a Qualified IPO in any given context.
Qualified Small Business Stock (QSBS) refers to shares in a C corporation that meet certain criteria as outlined in Section 1202 of the Internal Revenue Code. If shares meet these criteria, then under federal tax law, investors may be eligible for significant tax benefits, including the possibility to exclude a portion, or even all, of their gain from the sale of these shares from federal income tax.
Here are the criteria for a stock to qualify as QSBS:
The stock must be issued by a U.S. C corporation that has gross assets of $50 million or less at the time of and immediately after issuance.
The corporation must be a "qualified small business", meaning it must use at least 80% of its assets (by value) in the active conduct of one or more qualified trades or businesses.
The investor must acquire the shares at their original issue (not from a secondary market), directly or through an underwriter.
The stock must be held for more than five years.
Certain types of businesses are not eligible, including those engaged in services such as law, health, consulting, athletics, financial services, and businesses where the principal asset is the reputation or skill of its employees.
Tax law is complex and changes regularly. Moreover, state tax treatment of QSBS can vary. As such, it's crucial to consult with a tax advisor or legal professional to fully understand the potential tax implications of investing in or issuing QSBS.
In the context of venture capital, a ratchet is a mechanism used to protect investors in the event of a "down round," which is a subsequent financing round where shares are issued at a lower price than in previous rounds.
There are two types of ratchets: full ratchet and weighted average ratchet.
Full Ratchet: This is the more investor-friendly version. If any future shares are issued at a price lower than what the investor originally paid, the full ratchet provision adjusts the price of the original shares to the new, lower price. This can significantly dilute the equity of founders and other shareholders.
Weighted Average Ratchet: This is a more company-friendly provision. The weighted average ratchet also reduces the price of the investor's shares if a down round occurs, but it does so based on a weighted average of the old and new issue prices, rather than simply reducing to the new lower price. This results in less dilution than a full ratchet.
Ratchet clauses can protect investors from the dilution of their ownership stake in a company. However, they can also have significant implications for the company and its other shareholders, particularly in a down round, so it's important to consider these carefully when negotiating investment terms.
Redemption rights are a contractual term that allows investors, typically preferred shareholders, to sell their shares back to the company after a certain period of time, usually at the original purchase price plus any accrued dividends.
The inclusion of redemption rights in a venture capital or private equity deal provides a way for investors to achieve liquidity if the company has not had an exit event (like a sale or IPO) within a certain timeframe. These rights are often subject to certain conditions and may be exercisable at the option of either a majority or a specified percentage of the preferred shareholders.
It's worth noting that redemption rights can create significant financial pressure on a company, particularly if the company is not performing well. If the company does not have the cash available to buy back the shares, it could be forced into bankruptcy or liquidation. Therefore, these rights are a point of negotiation in investment agreements and may not always be granted.
Investors and companies should carefully consider the potential implications of redemption rights before including them in an agreement. As with any contractual term, it's important to seek appropriate legal advice when drafting and negotiating these provisions.
Recurring revenue is the portion of a company's revenue that is highly likely to continue in the future. This is revenue that is predictable, stable and can be counted on in the future with a high degree of certainty.
In many businesses, particularly those that operate on a subscription model such as Software-as-a-Service (SaaS) companies, recurring revenue can make up a significant proportion of total revenue. This predictability of income can be very attractive to investors as it provides a degree of financial stability and can be a sign of a sustainable business model.
Recurring revenue can be categorized into several types:
Subscription Revenue: This is revenue generated from customers who pay on a regular basis for a product or service, such as a monthly software subscription or a gym membership.
Renewal Revenue: This is revenue from customers renewing their contracts, which is common in industries like insurance or services with contract terms.
Consumables Revenue: This is revenue from customers who regularly purchase products that are used up and have to be bought again, like printer ink or coffee pods.
Contractual Revenue: This is revenue generated from long-term contracts, where the customer agrees to purchase a product or service over a certain period.
Understanding the recurring revenue model and its potential benefits is crucial for investors, especially when evaluating investment opportunities in companies that rely on this type of revenue.
Registration rights refer to the legal rights that certain investors have which require a company to register the investors' shares with the Securities and Exchange Commission (SEC). Registration allows these investors to sell their shares publicly in the secondary market, enhancing their liquidity.
These rights usually come into play when the shares were originally issued in private placement transactions, such as in venture capital or private equity investments, which are typically not registered with the SEC and therefore cannot be publicly traded.
Registration rights can come in different forms:
Demand Registration Rights: These allow the holder to request that the company register their shares with the SEC. There are typically limits on how many times investors can demand registration.
Piggyback Registration Rights: These allow the holder to include their shares in a registration initiated by the company or by other investors. These rights are usually unlimited.
S-3 Registration Rights: These are a specific type of demand registration right which allow the holder to request that the company register their shares on Form S-3, which is a simpler, shorter registration process for companies that meet certain criteria.
Registration rights can provide investors with greater flexibility and potentially higher returns by enabling them to sell their shares publicly. However, these rights are often a point of negotiation in investment agreements and can impose significant costs and administrative burdens on the company. As such, both companies and investors should carefully consider the implications of these rights when negotiating investment terms.
Right of first refusal is a contractual right that maintains investor control and prevents unwanted changes in company ownership. Venture capital agreements often include ROFR to give investors priority in purchasing shares being sold. Co-sale rights complement ROFR, enabling investors to exit proportionally in significant share transactions.