The Startup Encyclopedia
Browse our end-to-end glossary designed to help you better understand the startup landscape.
Startup accelerators are typically fixed-term and cohort-based programs that include a wide range of benefits including: educational sessions, access to legal, financial, go-to-market, engineering and other resources, discounted technology subscriptions (AWS, Google Ads, MailChimp…etc.) and mentorship. They are highly competitive, run for 6-8 weeks, are occasionally fee-free, and culminate in a public pitch event or demo day. Some of the most well-known accelerators include: YCombinator, 500 Startups, Angelpad, Techstars, GBeta, and Plug and Play.
An accredited investor is an individual who either:
- Has a net worth that exceeds $1 million (alone or with a spouse)
- Has earned an excess of $200,000 in each of the prior two years (or $300,000 together with a spouse or spousal equivalent), and reasonably expects the same for the current year.
Someone can also be considered “accredited” if they hold in good standing a Series 7, 65 or 82 license. Accredited investors can participate in venture capital, angel investments, real estate investment funds, private equity funds, hedge funds, and more.
While the criteria to become an accredited investor is very specific, there’s no standardized federal verification process. It’s up to each startup to verify the status of a potential investor, before allowing them to contribute to a round of funding.
Accrual accounting is the recognition of revenues and expenses when a transaction occurs rather than when the eventual payment is received. The method is in line with the matching principle, which requires revenues and expenses to be recognized in the same period in which they are incurred. The purpose of this form of accounting is to match revenues and expenses to the time period in which they were incurred, as opposed to the timing of the actual cash inflows and outflows related to them.
An administrative charge is a fee charged by a lender, bank, fund or other investment group for administering a new loan, line of credit, convertible note, and other financing vehicles to your business. Providers use this line item to cover the expenses related to record-keeping, filing and/or other administrative costs. It’s also referred to as an “administrative fee”.
The aggregate subscription amount is the total dollar amount of the pledged subscriptions under the subscriptions agreement. In other words, it is the gross amount of money that you receive from investors, funds, and groups from a stock, debt or options offering. It is calculated by multiplying the strike price per share by the number of shares purchased in the offering.
Amortization is the process of spreading out the payback of a loan into a series of fixed payments, over a fixed period of time. Upon receipt of the final payment in the payment schedule, the loan is considered “satisfied”, or “paid off”.
Whenever possible, request an Amortization Table to evaluate different loan options. Prior to selecting a plan, clarify if the rates in the amortization table include the additional fees related to the loan, such as: administrative fees, origination fees, preparation fees, processing fees…etc.
Ancillary documents, also known as supporting documents, are certificates, agreements, forms, and other written or recorded documentation that relate to a main document. They are typically used to verify and support a main document, such as your officer certificate (compliance certificate), secretary certificate, or board consent and shareholder consent document.
An angel group is a professional organization made up of individual angel investors who work together to identify and evaluate investment opportunities. When said opportunity is identified, they pull from the pooled funds to write a single check to the business.
The benefit of receiving funding from an angel group is that they typically have shared knowledge in the space and connections with industry operators. They also typically have connections to advisors and later stage investors, to whom they will likely introduce you.
Angel investors (angels) are typically accredited investors who use their own wealth to provide capital to startups and other small businesses in exchange for equity in the business. The check size usually ranges from $5,000-$150,000 for a 3-20% stake in the business. Angels have historically invested in startups at the idea-stage when it is pre-revenue.
Unlike an angel group, an angel syndicate is an informal group of accredited investors who can select to opt-in or out of individual investment opportunities. Each opportunity requires investors to write a new check, with which they pool together to invest (similar to crowdfunding).
The benefit from receiving funding from an angel syndicate, is that they typically are made up of individual operators who invest on the side vs a group of professional investors. Depending on your business model, these operators may introduce you to your first customers.
Annual recurring revenue, is a dollar figure that represents the normalized annual revenue that a company generates for providing a product or service. Used to determine the predictability of a businesses’ annual revenue, is typically applicable for companies that have a subscription component to their revenue model. Investors use a company’s ARR to quantify its growth, evaluate the success of the business model, forecast future revenues and provide revenue based financing.
Anti-dilution protection (also know as an anti-dilution clause, subscription right, subscription privilege, or preemptive right) is used by investors to protect their investment in the event of a down round, or a significant dilution event, such as the issuance of new shares for a round of equity financing, or the conversion of a convertible note. It is triggered when the strike price for a round is less than the strike price from the prior round. The two commonly known types of anti-dilution protection include: "full ratchet" and “partial ratchet/weighted average.”
An acqui-hire is the purchase of a company for their employees rather than their product/service. Acqui-hires are typically completed in tech startups due to the fierce competition for talent and the general lack of capital constraints—e.g. the going rate for an engineer is often more than $1 million. Google, Facebook, Apple, Twitter, Hubspot, and Dropbox are just a few of the large tech companies that have recently completed an acqui-hire.
An Arc Advance, also known as a merchant cash advance, or receivables financing, is a form of revenue based financing that enables startups to fund their growth, by converting future revenue into upfront capital. With an Arc Advance, startups can receive up to $50M in funding without debt or dilution, so they can accelerate their growth and extend their runway.
The Arc Card is a flexible corporate card for fast-growing companies. It comes with a simplified rewards program, unparalleled control and visibility, credit lines that grow with you, and a remarkably simple interface. With the Arc Card, best-in-class comes standard.
Arc Runway provides financial insights in minutes, so you can analyze your net cash burn and efficiently deploy your capital to maximize your runway. By leveraging the insights from Arc Runway, you can weather a changing macro environment, and maintain ownership, control and operating flexibility.
Arc Treasury is the software bank for SaaS startups with the scale, speed, and flexibility that you deserve. It's built on top of industry-leading rails, meaning you benefit from the latest tech without any of the traditional drawbacks. With Arc Treasury, you can onboard in minutes and access funding in just seconds.
“Asset Lite” refers to the amount of assets on a business's balance sheet. A business that is considered “asset lite” has little to no depreciating assets on their balance sheet. Businesses with an asset-lite business model typically delivers a better return on assets, lower profit volatility, and greater flexibility, compared to asset-heavy models. Examples of asset-lite businesses include: Airbnb, Uber, Lyft, Doordash, Instacart, and Postmastes.
The maximum number of shares that a company is allowed to issue, based on its articles of incorporation, is also known as its authorized shares. A company's outstanding shares can never exceed its number of authorized shares. The total number of a company's outstanding shares is the sum of the float (the number of shares actually available to trade) and the restricted shares (reserved for employee compensation and incentives).
The Automated Clearing House (ACH) is a standardized computer-network that facilitates the transfer of funds between tens of thousands of participating financial institutions. It consists of direct deposits and direct payments between businesses, governments, and consumers. The ACH system was designed to process payments in batches to reduce fees—which according to an article by Payments (“How Long Does an ACH Transfer Take?”) resulted in more than $55 trillion in transactions in 2019.
Bad debt is a term that describes loans and outstanding balances that are deemed uncollectible. They arise when a company is incapable of paying back debt, resulting in either delayed, reduced, or missing payments. These loans typically come with a high or variable interest rate and unfavorable terms.
As opposed to installment loans (or fully amortized loans) where all of the payment amounts are fixed, in a balloon payment, a lump sum is paid at the end of a loan's term. The final payment is significantly larger than all of the payments made before it, and as a result it is more risky so it often comes with a higher interest rate. The benefit is that the debtor has a lower initial payment, and typically lower ongoing monthly payments.
Bank reconciliation is the process of comparing a business’s bank balance to their books (e.g. their financial records). Differences between the records are reconciled, or adjusted/corrected, to make them align. This internal control is often used to prevent fraud.
Bargaining power refers to the relative ability of both parties in a negotiation to influence one another. In most negotiations, there is an inequality between the level of influence that both parties can exert, resulting in a one-sided compromise. However, in some cases, both parties have the same level of influence and thus they have equal bargaining power, resulting in a true compromise.
Benchmarking is the process of comparing the metrics, policies and procedures of an organization to other best-in-class industry participants. Benchmarking is often used by both internal and external parties of an organization. Here are two examples of benchmarking in practice:
- People Ops benchmark salary bands against companies in a similar industry, funding stage, and size to ensure their organization is in line with the competition.
- Investors benchmark the metrics of a potential opportunity to gauge its relative attractiveness.
You can benchmark your expenses to identify areas of overspend here.
The term bill of exchange, also known as a ‘commercial bill’, requires one party to pay a fixed sum of money to another party on demand or at a predetermined date. Bills of exchange typically involve three parties—the drawee (who pays back the sum), and the drawer (who lent and is repaid the sum).
Binding agreements are legal contracts that can be enforced at both the federal and state level. To be considered “binding” an agreement must meet the following criteria:
- Legality — The contract must align with all federal, state, and local laws.
- Consideration — The benefit that both parties receive from the agreement.
- Capacity — All parties must be in a position to legally sign the contract.
- Offer and acceptance — One party offers something and the other party must accept it.
- Mutuality — Both parties must have intentions to complete their obligations, and have an understanding that they will be bound by the contract.
The term “board of directors” refers to the group of individuals that oversee the strategy and management of an organization. They are typically elected by a vote, but can also be elected as a stipulation of their participation in a funding round. The bylaws of an organization generally outline the number of board members, the election process, and the meeting frequency.
Board rights refer to the set of abilities that each board member of an organization has. These rights can range from calling a board meeting, raising a discussion item and voting on it, to requesting and inspecting all of a company's financials, and approving future rounds of funding. The full list of board rights are outlined in the bylaws of an organization.
Bootstrapping refers to an operating model where a newly formed company, or startup takes on minimal capital, and instead grows by reinvesting its revenue. Bootstrapped companies often leverage other forms of non-dilutive financing, such as revenue based financing to accelerate their growth and extend their runway. Examples of bootstrapped companies include Dell Computers, Meta (formerly Facebook), Apple, Clorox, Coca Cola, and Hewlett-Packard.
The bottom up financial model, also known as “bottom-up forecasting” is a method of estimating future performance by starting with low-level data, such as a company’s average monthly sales volume, to build “up” to its projected revenue for the upcoming year. Button-up forecasting is the opposite of top-down forecasting which starts with the TAM of a business to estimate its projected revenue for the coming year.
Break even point refers to the level at which a company’s revenue equals its expenses. When a company’s expenses exceed its revenue, it experiences a loss (the monthly loss is known as its burn rate). Conversely, when a company’s revenue exceeds its expenses, it experiences a profit. Ultimately, the goal of any venture-backed startup is to reach and exceed its break even point.
A bridge loan is a type of short-term loan that is typically taken out for a period of 6 to 12 month for the purpose of “holding-over” a company until they can secure longer-term financing or they can receive significant cash inflows from a signed deal. Bridge loans do not come with extensions, so they are not preferred during periods of economic contraction.
A more founder-friendly alternative to a bridge loan, is revenue based financing, which enables a company to convert their future revenues into upfront capital.
Bullet loans, also referred to as balloon payment loans, come with lower monthly payments, a higher interest rate, and a required lump sum payment at the end of the loan's term. Sometimes, the monthly payment is interest only and does not apply towards the principal, resulting in the entire principal of the loan plus interest being due at the end of the loan term.
Bullet loans are most frequently utilized when a business expects to receive a large inflow of cash at some point in the near future, but they need cash today to continue operations. So they take out a bullet loan with a term that best fits their needs, and they pay it back when they receive said inflow.
While bullet loans can be useful for some circumstances, a more founder-friendly alternative is revenue based financing, which enables a company to convert their future revenues into upfront capital.
A company’s burn rate refers to the sum of its cash outflows and its cash inflows each month. During periods of economic expansion, a venture-backed startup’s burn rate is typically much higher than it is during periods of economic contraction. A company’s burn rate is used in conjunction with its growth rate to calculate its runway, here’s a helpful tool to calculate your runway.
When evaluating an opportunity, investors most frequently review its business fundamentals which can include its cash on hand, churn, burn rate, growth rate, and more. A business’s fundamentals vary based on its model, but they are always quantifiable and are almost always used to determine how it is performing.
Business fundamentals are also used by a company’s internal management team to evaluate the performance of each of the functional areas. E.g. marketing and sales can be evaluated based on their number of opportunities, closed-won deals, and cost-per-opportunity; customer experience can be evaluated based on the number of closed tickets and average net promoter score.
Business loans refer to any type of monetary exchange where capital is borrowed, with the expectation that it be paid back (often with interest) at an agreed upon point in time. There are many forms of business loans, including bullet loans, 7(a) Loans, 504 Loans, SBA Loans, Forgivable Loans, Term Loans, MicroLoans, and more.
Unlike business loans, revenue based financing (RBF) does not come with an interest rate, instead it typically comes with a discount rate. Company’s leverage RBF to convert their future revenues into upfront capital.
During a buyout, the majority share of a company’s ownership is acquired. By doing so, the acquiring company "buys out" the equity holders of the target company. A buyout is sometimes also known as a hostile takeover, if the buyout is against the wishes of the company's management team.
The “cap” on a convertible note outlines the maximum valuation at which the investment in the convertible note can convert into equity.
Capital gains are equivalent to the appreciation in an asset's value that is realized when it is sold—they apply to any type of asset, including investments and those purchased for personal use.
There are two forms of capital gains, short-term (which are held for one year or less before being sold) or long-term (held more than one year before being sold).
Capital growth is the appreciation in the value of an asset or investment over time. It is a percentage that is measured by subtracting the current value of an asset from its original purchase price, divided by the original price.
The term ‘capital under management’ refers to the amount of money that is available to invest by a fund, group or syndicate.
The cap table outlines all of the owners of a company, their equity percentage, equity dilution, and value of equity in each round of funding.
The term ‘cash advance’ refers to a lump sum payment that a company receives in exchange for making a series of fixed monthly payments in the future.
The cash flow statement is a financial statement that outlines all of the revenues and expenses of a company over a defined period of time.
The cash inflows of a business equal the excess of its revenues over its expenses.
The cash outflows of a business equal the excess of its expenses over its revenue.
The cash position of a company is equivalent to the amount of cash that it has on its books at a specific point in time.
The certificate of incorporation is a legal document that relates to the formation of a company.
The term ‘change in control’ relates to a contractual provision that gives a party certain rights (such as consent, payment or termination) in connection with a change in ownership or management of the other party.
The churn rate of a business refers to the percentage of its customers that have “churned” or ceased being a customer in a specified time period. The typical time period used to calculate a businesses churn rate is one month—enabling them to map it over time and identify trends.
The term ‘cliff vesting’ refers to the period of time in which a new employee must remain employed by the company in order to “unlock” a portion of their shares. The typical cliff for new stock-based compensation agreements is one year.
Collateral refers to any asset that is owned by a company, and is used to secure a loan or other debt-investment.
Common stock, like preferred stock, is a form of ownership in a company. Typically common stock is owned by employees and founders, while preferred stock is owned by investors.
Compliance costs are expenses that arise when a company adheres to regulatory requirements.
The term ‘condition precedent’ refers to the requirement in a deal for a condition or an event to occur before a right, claim, duty, or interest arises. If the condition precedent is not met, neither party is obligated to perform.
A contingency is a requirement of a deal, that if not satisfied results in the other party being released from its obligations.
A contingent liability provides coverage for losses to a third party for which the insured is vicariously liable. There are three types of contingent liabilities:
- Probable - can be reasonably estimated to occur (and must be reflected within financial statements).
- Possible - are as likely to occur as they are to not occur (and need only be disclosed in the financial statement footnotes)
- Remote - are extremely unlikely to occur (and do not need to be included in financial statements at all).
An amendment is a change that is made to a contract. It is mutually agreed to by both of the parties and is used to add or delete sections or phrases, or change sections or phrases within it. With an amendment, the original contract remains intact, with typically only minor adjustments.
Conversion rights give investors the right to convert their preferred stock into common stock in the business. There are two forms of conversion rights—optional and mandatory. Mandatory conversion rights force investors to convert their shares in an exit or liquidation event.
A convertible note is a debt vehicle used by early-stage investors to invest in a startup that doesn’t have a valuation—it starts as debt and transforms into equity upon certain milestones being achieved. The four main terms of a convertible note include its: interest rate, discount rate, maturity date, and valuation cap.
The term ‘convertible preferred stock’ refers to the class of shares that give the holder the right to convert their shares into a fixed number of common shares after a predetermined date.
A corporate bond is a form of debt issued by a company to raise capital. An investor who buys a corporate bond lends them money in exchange for a series of fixed interest payments.
The cost of capital refers to the expenses related to a company’s raised funding. For revenue based financing the cost of capital is straightforward, it’s a fixed dollar amount. For convertible debt vehicles, such as SAFEs or convertible notes and equity financing, the total cost of capital is much less straightforward, because it depends on the ultimate exit valuation of the business and the provisions contained in the agreement.
The term ‘covenant’ refers to the provisions in a debt agreement that protect lenders from borrowers defaulting on their obligations due to financial actions—when breached, covenants trigger compensatory and other legal actions. There are two forms of covenants: affirmative covenants and negative covenants—negative covenants force borrowers to refrain from certain actions that could result in their inability to repay existing debt; affirmative covenants force borrowers to perform specific actions or maintain certain balances.
A credit facility, also known as a line of credit, refers to the amount of debt capital available to a business. The longer the credit history, the larger the available credit facility is for the business.
The credit history of a business, also known as its repayment history, refers to its ability to repay its debts over time. The longer the period of consistent repayments, the better the credit history of a business appears.
A creditor is a wealthy individual or institution that issues credit (debt) to another company. Creditors typically require collateral or personal guarantees to issue loans.
The term ‘crowdfunding’ refers to a form of raising capital from a large group of individuals, typically through the internet. There are three types of crowdfunding including: donation-based, rewards-based, and equity crowdfunding. Unlike raising capital from traditional funds and groups, the individuals who provide capital via crowdfunding do not have to be accredited investors.
The term ‘cumulative dividends’ refers to the amount of required dividend payments that a company has agreed to pay to its preferred shareholders. Cumulative dividends must be paid, even if they are paid at a later date than originally stated.
The current assets of a company include all of the assets that a company reasonably expects to use or exhaust within one year, which may include: its cash, accounts receivable, and inventory.
The current liabilities of a company include all of the debts or obligations that a company expects to pay back to its creditors within one year, which may include its: accounts payable, short-term debt, dividends, and notes payable.
The amount of money that a company is willing to spend on converting a customer is called its ideal customer acquisition cost.
The term ‘customer lifetime value’ is a dollar figure that describes what a customer is worth to the company. The higher the LTV of a customer, the more a company is willing to pay to acquire them.
The term ‘deal lead’ refers to the investor or fund who leads the funding round of a startup and sets the terms on which the investment will happen.
Debt consolidation is the process of taking out one loan to pay off some portion of all the other loans that a company has. The new loan typically has more friendly repayment terms.
The term ‘debt financing’ refers to any financial product that involves the exchange of capital for a debt instrument, such as a loan, or convertible note.
The term ‘debt-to-equity’ refers to the relative ratio of a company’s liabilities to its shareholder equity—it is used to evaluate how much leverage a company is accessing. Company’s with a high debt-to-equity ratio carry a higher risk to shareholders.
The term ‘debtor’ refers to a company that is in debt to another company due to a financial arrangement, such as a loan or convertible debt product.
A loan is considered “in financial default” when it cannot reasonably be expected to be paid back, or when only the interest can be paid back (i.e. interest-only payments).
A loan is considered to be in a “technical default” when there is a failure to uphold an aspect of the loan terms (other than the regularly scheduled payments).
The term ‘depreciation’ refers to the relative drop in an asset's value, due to its decreasing useful life over time. There are four main forms of depreciation—straight-line, declining balance, sum-of-the-years' digits, and units of production.
Dilution refers to the process of decreasing existing shareholders relative ownership in the company, through the issuance of new shares in said company or through the conversion of options.
Early investors typically try to prevent the dilution of their shares by establishing provisions in their term sheets including: full or partial ratchets.
The term ‘dilutive financing’ refers to any form of fundraising where capital is exchanged for equity in the business.
The term ‘direct lender’ refers to a financier that provides the actual capital for a loan without an intermediary. By eliminating intermediaries, direct lenders are able to offer more competitive interest rates on their debt products.
Dirty term sheets, also known as predatory term sheets, are used to describe term sheets that are riddled with one-sided provisions and terms that are not in the founders’ favor. They are often deployed when a startup wants to raise capital while maintaining its inflated valuation and are based on internal rate of return mechanics other than price such as—price in kind dividends, or guaranteed multiple hurdles. Dirty term sheets misalign the interests of investors and operators, as investors focus their efforts solely on pushing the startup to go public. AVOID dirty term sheets at all costs.
A disbursement is exactly the same as a dividend except that the term “dividend” is used for companies that are established as C Corporations, and the term “disbursements” is used to describe cash payments from S Corporations and mutual funds.
A disclosure schedule outlines all of the fact-specific disclosures (or exceptions to specific statements) relating to the seller's representations and warranties. There are two types of disclosures—affirmative disclosures and negative disclosures. Negative disclosures list the exceptions or qualifiers to the seller’s responsibilities and warranties, whereas affirmative disclosures list the actual requirements.
The discount rate refers to the percentage used to discount a company’s future cash flow to its equivalent present value. The typical discount rate for SaaS startups is 20%, but it can be upwards of 40% in certain situations.
A company disrupts another when it introduces a competing product at a more attractive price, with a better interface or feature set, or with unique positioning. Typically established legacy companies are disrupted by new startups, but they are sometimes disrupted by other legacy companies.
Recent examples of companies with disruptive business models include: Airbnb (disrupting hotels), Uber (disrupting taxi cabs), Doordash (disrupting food delivery).
A dividend is a payment made by a company to its investors and shareholders—it’s typically paid out quarterly.
The double entry accounting system is a form of accounting that requires two entries for every transaction.
A down round occurs when a startup raises a new round of funding at a lower valuation than a previous round. When this occurs, typically the investors invoke their full (or partial) ratchet rights to ensure that they are not diluted.
The term ‘drag along rights’ refers to the ability of majority shareholders to force minority shareholders to join in the sale of a company at the same price, terms, and conditions as they received. If applicable, the drag along rights will be detailed in the provisions of the term sheet.
Startups draw down their loans or credit lines when they access the capital that their lenders provide. Typically, startups shouldn’t draw down more than 50% of the loan amount to ensure they don’t surpass the ideal loan to value ratio.
The term ‘due diligence’ refers to the investigation process that takes place when investors are evaluating potential opportunities, or when a company is considering entering into a contract with another entity. Like the duty of care, the due diligence process centers around the research that a reasonable person would be expected to conduct.
The term ‘duty of care’ refers to the responsibility of the directors and officers of a company to conduct a reasonable amount of diligence prior to making a decision in good faith that aligns with the best interests of the company. The decision they make must also align with the decision that a prudent person would reasonably be expected to take in a similar position and under similar circumstances.
The term ‘duty of loyalty’ refers to the responsibility of all directors and officers of a company to act at all times in the best interest of the company, without personal conflicts of interest. One such example is the requirement to keep all company information confidential, and to not misuse or disclose such information.
The term ‘EBITA’ refers to a company’s earnings before interest, taxes and amortization—it is used to determine the financial performance of a company, and to compare the performance of two companies in the same line of business.
The term ‘encumbered’ refers to securities that are owned by one entity, but are also subject to a legal claim by another. When a company borrows from another, legal claims on the securities owned by the borrower can be taken as collateral by the lender in the event that the borrower defaults on its obligation. Encumbered assets are subject to restrictions on their use or sale, and in some cases, they cannot be sold until the outstanding debts belonging to the owner of the securities are paid back to the lender who holds the claim against them.
Equity, also known as startup equity, refers to the degree of ownership stake that investors, founders and employees have in the business. Typically, the equity that employees and founders earn is subject to a four year vesting period and a one year cliff.
Equity dilution is a decrease in the ownership percentage of a company held by individual shareholders, resulting from the issuance of new equity. This can happen when a startup fundraises or raises capital by issuing additional shares of stock.
The term ‘equity financing’ refers to a funding arrangement where an investor provides capital to a startup in exchange for equity or stock in the company. Venture capitalists, angel investors, angel syndicates, private equity groups and more all invest in companies via equity financing.
The term ‘exclusivity’ refers to the provision in some term sheets that limits the seller's ability to solicit an offer from or negotiate with a third party during a specified time period. It can also refer to the term in the contract that restricts one party from working with or selling to a competing party.
An exit, or liquidation event occurs when a startup goes public through an IPO, is acquired, or goes bankrupt. After such an event, the investors, founders and employees of said company have the opportunity to sell their shares and “cash out”.
An expense is any cost associated with running a business including: payroll, overhead, rent cost of goods sold…etc.
A facility, also known as a credit facility or debt facility, is a type of financing that is provided to startups to fund their operations. All debt or credit facilities come with a set of repayment terms which outline the principal amount, interest (or discount) amount and fixed payment schedule.
The financial statements of a company include its: balance sheet, income statement and cash flow statement. It's used to convey the business activities and the financial performance of a company and is audited by government agencies, accountants, firms, etc. to ensure its accuracy for tax, financing, and investing purposes.
Fixed interest rate loans come with a consistent interest rate over the term of the loan, unlike variable interest rate loans.
A flat round occurs when a startup raises a new round of funding at the same valuation as their previous round of funding. Unlike down rounds, flat rounds are neither good nor bad.
The float of an employee or investor's stock is a dollar figure that represents the difference between the strike price of their shares or options and the current fair market value of said shares or options.
The greater the float, the better (or worse) the investment is—yes floats can be negative if the current strike price is lower than the strike price they initially paid.
The term ‘flow of funds’ describes the process of how money moves between lenders or other capital providers and the company receiving the funds.
Startups make predictions, or “forecast” their revenue, expenses and growth rate for the year using a variety of methods including: top-down, bottom-up and run-rate.
Forgivable loans are a form of debt that are “forgiven” or considered satisfied, after a period of time or a specified repayment milestone (often 80% of the loan value). They are typically provided by government organizations, such as the SBA.
Founders shares, also known as founders equity or founder stock, refers to the equity that is allocated to the founders of an organization. In reality, there is no legal difference between founder's stock and common stock, other than the “founder’s stock” may come with additional restrictions, voting rights, and other rights.
The free cash flow of a business is the leftover cash it generates after paying for its operating expenses and capital expenditures (CapEx). The more free cash flow a company has, the better it is positioned to pay down debt and grow, thus the more attractive it is to investors.
As the name implies, in the friends and family round, your friends and family provide a capital injection into the business. It’s typically the first informal round of capital put into the business, preceding the pre-seed funding round.
The term ‘fully diluted shares’ refer to the total number of common shares of a company that are outstanding and available to trade after all possible sources of conversion, such as convertible bonds and employee stock options, are exercised.
A fully drawn advance occurs when a borrower pulls their entire loan principal upfront and agrees to repay it plus the interest according to the amortization schedule and repayment terms.
A funding round includes any formal cash injection into a business by an investment fund or accredited investor. Funding rounds for most startups typically range from pre-seed to series e, but hypothetically can go on forever.
The term ‘goodwill’ refers to the set of intangible assets that a company has on its balance sheet including its: brand recognition, customer and employee relations, and any patents or proprietary technology. To find the value of the goodwill that a company recognizes, subtract the book value of the company from its purchase price. Examples of companies with the largest recognized levels of goodwill include: Microsoft, Amazon, Apple and Alphabet (Google).
Grant awards are essentially monetary gifts provided to companies that do not need to be paid back. They are typically awarded by government organizations such as the SBA, but they are also provided by other organizations who host pitch competitions.
The monthly gross burn rate of an organization is equal to its total expenses for said month including its rent, salaries, and other overhead.
The monthly gross income of a business is the total of its revenues for said month before any expenses, depreciation, or taxes. The gross income of a business is also known as its gross profit.
The gross margin of a product or service is a percentage that is calculated by subtracting the cost of goods sold from revenue, then dividing said figure by the revenue. The gross margin for software businesses is typically much higher than businesses that sell products.
The strategy of growing at any cost indexes almost exclusively on driving sales or users, without much regard for the quality of said users or the cost associated with securing them. Oftentimes a ‘growth at any cost’ strategy results in an insanely high burn rate, because the cost of acquiring the new customers is more than what they are worth to the business.
Growth capital is injected into businesses at critical points in their lifecycle, enabling them to acquire more customers and hire more team members—ultimately resulting in an accelerated period of growth. Growth capital comes in many forms, but the most common include: venture capital, venture debt and revenue based financing.
The term ‘growth rate’ refers to the percentage change of a specific variable within a specific time period—for example: users, customers, and valuation. The growth rate of a business is calculated by subtracting the ending value in question from the starting value, and dividing the result by the starting value. It is used by investors to predict future performance.
Startups reach the growth stage when they have acquired a fair amount of customers, generate a steady source of income, and have proven product-market fit.
While there are a variety of growth strategies, one thing remains constant—the goal: to convert more customers or get more users. The three most common growth strategies include market penetration, market expansion, and market development.
The term ‘guarantor’ describes an individual who promises to pay for the company’s debt in the event that the company defaults on its loan obligation, by pledging their own assets as collateral against the loans. There are two forms of guarantors: limited and unlimited—limited guarantors are typically only responsible for a portion of a loan, whereas unlimited guarantors are responsible for the loan in its entirety.
Hard money describes fiat money that has a stable market value relative to real goods and services and a strong exchange rate relative to foreign currencies. Businesses may choose to hold hard money because its stable value makes it a more conducive store of value, unit of account for profit-and-loss accounting, and medium of exchange.
Usage in lending
A hard money loan is a type of loan that is backed by the value of a physical asset, such as a car or home. Hard money loans typically have shorter terms and higher rates than traditional loans, and are more common in the real estate industry.
Hard money lenders are private lenders that provide funding for a hard money loan.
A hedge is an investment that protects an investor's finances from being exposed to a risky situation that may result in a loss of value. Hedges serve as a form of insurance – they help prevent an investment from losing value by offsetting losses with gains in another investment.
Hedge funds are investment pools used to invest in securities or other investments with the goal of generating positive returns. Most hedge funds typically have more leeway to pursue investment strategies that may inherently carry a higher risk of loss.
Indemnification is a form of insurance compensation for damages or loss. A party may choose to indemnify or pay for the potential losses or damages caused by another party.
An industry vertical is a very specific classification and description of a group of companies that focuses on a shared niche or specialized market spanning multiple industries.
Information rights is a provision in a term sheet that outlines the information a company must provide its investors beyond what state law requires.
Examples of information rights provided to preferred shareholders in private companies include
financial statements, capitalization table, budget, and inspection rights.
Insolvent is a term used to describe a business or entity that is unable to pay back the debt it owes to its creditors.
Intangible assets are assets that are not physically tangible in nature. Brand recognition, goodwill, intellectual property are all examples of intangible assets. Intangible assets created by a company do not appear on a corporate balance sheet and have no recorded book value.
Intellectual property is a type of intangible asset and refers to patents, trademarks, copyrights, and trade secrets owned by a company. Intellectual property is protected by law.
Interest is the amount a lender charges to a borrower for any form of debt given, usually expressed as a percentage of the principal amount. The interest rate could be considered the fee or price a debtor pays in order to borrow capital.
An investment is an asset or item an investor acquires with the goal of generating income or appreciation. Investments involve the outlay of capital whether it be in the form of time, effort, money, or an asset for future payoff that is greater than what was initially put into the investment.
An investment multiple, also known as a target rate of return, is the ideal percentage that the investor seeks to gain from their investment over a period of time. Typically VCs look set a target rate of return of between 25% and 35% per year.
An investment vehicle is a financial instrument, product, or container that houses a particular investment strategy that allows investors to earn a positive return through income and capital gains. Investment vehicles each carry different degrees of risk and can include individual securities such as stocks and bonds as well as pooled investments like ETFs and mutual funds.
An investor is a person or entity that commits capital with the expectation of generating income or profits.
An investor rights agreement outlines all of the rights that an investor has which may include, but are not limited to voting rights, inspection rights, rights of first refusal, and observer rights.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.
An invoice is essentially an IOU used by businesses to charge their customers. They are typically leveraged in situations where a large dollar amount is due, and a credit card is not the most appropriate form of payment.
Invoice financing, also known as receivables financing, is similar to receivables factoring, except that in receivables factoring the company gives up the rights to the receivables, whereas in invoice financing the company maintains the rights to the receivables and instead borrows money against them. Invoice financing helps businesses improve cash flow, pay employees, and reinvest in operations and growth, because they can access cash today by eliminating the time between customer-go-live and the eventual bump to their top line.
An issue is a process of offering securities in order to raise funds from investors. A business may issue bonds or stocks to investors in exchange for financing.
The term ‘issued shares’ refers to the number of shares that a company has allocated and are subsequently held by shareholders.
Kickers are rights, exercisable warrants, or other features that are added to a debt instrument to make it more desirable to potential investors by giving the debt holder the potential option to purchase shares of the issuer.
A lead investor is the primary investor of a funding round. They are responsible for setting the key terms in the capital raise and oftentimes (but not always) is the largest investor. Lead investors play an important role since they act as a facilitator during the capital raise process as the terms secured in the initial term sheet will apply to all subsequent investors in the round.
Legal fees are often assessed when negotiating term sheets, the related provisions or other transactions that require council. It is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. Lawyers are expensive, but they protect your best interests and your bottom line—as the saying goes: you get what you pay for, so don’t always go the cheaper route.
Leverage is a business and finance strategy where companies leverage debt to build financial assets. Businesses create debt by borrowing capital from lenders with the promise that they will pay off this debt with added interest. A business is labeled as highly-leveraged when their total debt outweighs total equity.
To calculate financial leverage take total company debt and divide by total shareholder’s equity:
- Leverage = total company debt/shareholder’s equity
- Leverage = total company debt/shareholder’s equity
Liabilities are the legal debts a business owes to third-party creditors and can include accounts payables, notes payables, and bank debt. Long term liabilities are obligations that are due after more than one year. Mismanagement of liabilities can result in negative consequences such as declining financial performance or bankruptcy.
A line of credit is a credit facility that a financial institution extends to a government, business, or customer which enables the borrower to draw on the facility as needed and repay either immediately or over time.
A Liquidation multiplier is a term that allows investors to receive a multiple of their liquidation preference in the event of a liquidity event.
An investor with one million shares of Series B preferred stock with an original issue price (OIP) of $1.00 would have a liquidation preference of $1 million. However if the same investor had shares with a liquidation multiplier of 2x, their liquidation preference would be $2 million.
Liquidation preferences are the set of key term in any investment or lending agreement that give investors and creditors the right to be repaid in the event of a company's bankruptcy or liquidation. This protection can be vital for investors and creditors, as it ensures that they will not lose out if the company goes under.
Liquidation waterfall defines the payout order in the event of corporate liquidation. Typically, the companys' preferred stockholders get their money back first, ahead of other kinds of stockholders (common shareholders) or debt-holders. These liquidation preferences can include a mix of standard and non-standard terms that further affect the payout order.
A liquidation or liquidity event is the acquisition, merger, initial public offering (IPO), or other action that allows founders and early investors in a company to liquidate some or all of their ownership shares.
Favorable liquidation events:
- Sales of a company for cash
- Sale of a company for shares
Unfavorable liquidation event:
- Company bankruptcy
A loan is considered “in default” when it cannot reasonably be expected to be paid back, or when only the interest can be paid back (i.e. interest-only payments).
Fees paid to a lender to process a loan. These fees are paid only after the loan is accepted.
The term ‘loan to value ratio’ refers to the assessment of lending risk that is calculated by dividing the loan amount by the lender-assessed value of the business. Generally speaking, most lenders consider a LVR of 80% or more as being risky.
The term ‘lock up period’ refers to the period of time following an IPO of a company when investors or other shareholders are not allowed to redeem or sell shares. The typical lock up period is 180 days, but it can last for over a year. Lock-up periods are not required by the Securities and Exchange Commission (SEC) or any other regulatory body, but are established to prevent large investors from flooding the market with their shares.
Loss of control occurs when a founder is removed from the leadership team of a company, via a board vote or a hostile takeover. A few founders that suffered a “loss of control” include: Steve Jobs (Apple), Jack Dorsey (Twitter), Andrew Mason (Groupon), and Jerry Yang (Yahoo).
Major investor rights define the threshold required to be considered a “major investor” and the associated rights that an investor receives for being considered as such. E.g. information rights, pro rata rights, co-sale rights, the right of first refusal…etc. Setting major investor rights is beneficial, because it can reduce the number of investors you have to coordinate or negotiate with during specific events—such as the sale of stock, or a liquidation event.
A management rights letter is an agreement between a company and an investor that provides the investor with certain "management rights"—allowing it to substantially participate in, or substantially influence the conduct of, the management of the portfolio company.
Mandatory conversions occur when a key event takes place, such as an IPO, acquisition or merger. They result in the preferred shares of a company being converted into common shares. Mandatory conversions are outlined in the provisions of a term sheet.
The margin of a company is calculated by subtracting the expenses from its revenues. The higher the margin, the more likely the company is to generate a profit. Software companies typically have higher margins versus companies that sell physical products.
Company’s mark down the price of products that are not selling well to liquidate their inventory—sometimes to the point of losing money for every item sold. In price wars, companies race to the bottom by marking down their price.
The mark up on a product or service is the dollar amount that is added to its cost, forming its selling price. It is calculated by subtracting the cost of the product or service from its selling price. The markup for software is often high, while the markup for physical products is typically low.
The term ‘market penetration’ refers to the adoption of a company's product or service relative to the total estimated market for that product or service. Most companies never reach 100% penetration, due to saturation, competition and other factors in the market.
The maturity date of a loan or other debt product, refers to a specific point in time when the final payment is due. The maturity date of a loan is outlined in the repayment terms.
The term ‘merchant cash advance’ refers to the purchase of a company’s receivables—the company receives a lump sum payment in exchange for making fixed monthly payments in the future.
Merchant cash advances are a form of receivables financing, and revenue based financing. They are the most founder-friendly way for startups to fuel their growth, as there is no debt or dilution. With merchant cash advances, startups can convert their future revenues into upfront capital so they can scale faster, on their terms and without restriction.
The term ‘mezzanine financing’ refers to a hybrid form of debt and equity financing, similar to a SAFE or convertible note, except that it gives the lender the right to convert its debt position into an equity interest in the company in the event of default. Startups leverage mezzanine financing to fund growth projects and to help with acquisitions. Mezzanine financing is subordinate to senior debt, and superior to both preferred and common stock.
Micro venture capital, also known as Micro VC is a form of investing in seed-and-early-stage startups. Typically micro VC funds have less than $50MM in capital under management, have an average check size between $25-$500k and they invest on behalf of their limited partners (as do other VC funds). Startups typically use the funds from a micro VC investment to bring their product to market.
A microloan is a type of loan typically used to finance entrepreneurial projects in impoverished or developing regions. Microloans are also offered to small businesses by the SBA, and can range from a few thousand dollars up to $50,000.
The Most Favored Nation Clause gives early investors the same rights and benefits received by later investors, if those rights and benefits are more favorable than those originally agreed to. MFN clauses are typically included in SAFEs and Convertible notes. MFN clauses give investors peace of mind—they are assured that they will not be disadvantaged compared to other investors in subsequent rounds, thus maximizing their potential returns.
Negative cash flow occurs when a business has more outgoing money than incoming money. New companies and startups are typically cash flow negative, while creditors and financiers are willing to overlook this in the early stages of a company’s life cycle – eventually, these companies need to move towards being cash flow positive to receive additional funding.
Negative covenants are restrictions placed on a borrower that restricts certain actions or behaviors. Examples of negative covenants can include: non-compete agreements that prevent a company from competing directly with another business for a specific period or a non-disclosure agreement that prevents a company from sharing trade secrets and proprietary information.
Net income, also referred to as net earnings, is calculated as sales minus cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses. Net Income is a proxy for a company’s profitability and is a business metric investors may use to evaluate how much revenue exceeds the expenses of a company.
Net profit is the amount of money a business earns after deducting all operating, interest, and tax expenses over a fixed period of time. In order to determine net profit, you need to know a company’s gross profit.
Net profit is an important business metric that signals the profitability of a business. If the value of net profit is negative, then it is called net loss.
Net worth provides a quick snapshot of an entity’s financial position, the metric can be applied to corporations, individuals, countries, and even sectors. Net worth can be calculated by taking the value of all the assets an individual or corporation owns and subtracting the liabilities they owe.
Clause that states or prevents the lending party from making an advance payment to the borrower.
Non-dilutive funding is a financing tool businesses can deploy to fund their operations. Non-dilutive funding differs from dilutive financing options in that the business is not giving up equity (diluting their ownership) in exchange for funding.
- No equity dilution - Because companies aren’t giving up an ownership stake in exchange for capital, debt financing helps founders maintain control over their business.
- Cheaper - While debt funding has to be paid back, the overall cost is far less than equity financing as future profits are all yours.
- Leverage - While debt financing requires revenue, it allows you to convert current and future revenue to leverage larger amounts of capital to power your growth.
- Debt is senior to equity in the capital structure which means debt lenders have priority in claims in the event of a bankruptcy.
- Harder to qualify for - Because debt lenders aim to minimize risk, qualifying for debt financing can be harder than equity financing.
- Liability - Some lenders require a personal guarantee as a backup which could mean founders are personally liable for repayment in the event of business failure.
- Warrants/Covenants - Some lenders include covenants(conditions) that have to be maintained as part of their funding requirement. Common covenants include the right to purchasing equity or pre-determined debt-to-equity ratios.
Offering periods are defined in a Employee Stock Purchasing Plan (ESPP). During the offering period, payroll deductions are accumulated to purchase shares on your behalf.
Opportunity costs represent the potential benefits that an individual, investor, or business forgoes when choosing one alternative over another.
An Option is a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset by a certain date (expiration date) at a specified price.
An option pool refers to an allocation of company equity that has been reserved for early investors or employees of a start-up company.
Fees paid to a lender to process a loan application.
Out-of-pocket costs refers to expenses incurred by employees that require a cash payment. The employer typically reimburses employees for these costs through an expense reporting system. Examples of out-of-pocket-costs include the cost of a business lunch with a client or the purchase of gasoline or tolls while engaged in company business.
Overdraft facilities are agreements drawn between a bank and an account holder that allows the entity to take out or use more money than what they have in their account. These overdraft facilities work similarly to an approved loan since the account holder only has to pay interest on the amount owed and only for the time it was borrowed.
Owner’s equity represents the owner’s rights to the assets of the business. To calculate owners equity, subtract the value of all liabilities from assets.
During a sale, holders of preferred stock get preferential treatment and are typically paid first before holders of common stock. What makes participating preferred unique even when it comes to preferred stock is that holders of this stock class are entitled to receive a share of any remaining liquidation proceeds on an as-converted to common stock basis, after they have already gotten back their liquidation preference.
Payback period refers to the amount of time it takes to recover the cost of an initial investment. In other words it is the length of time required for an investment to reach the break even point. The shorter the payback period, the more attractive a loan is to an investor.
Payback terms, also known as repayment terms, outline the principal, interest (or discount) rate, and monthly payment amount.
Payment-in-Kind refers to the instance where goods or services are used as payment or compensation in lieu of cash.
The term ‘personal guarantee’ represents an individual’s legal promise to repay credit issued to a business for which they serve as an executive or partner. Personal guarantees help extend credit worthiness and help businesses secure access to capital that they typically wouldn’t qualify for on their own.
Personal property is a class of property that can include any asset other than real estate. The main criteria qualifying an asset as personal property is that it is movable (not fixed permanently to one particular location).
Petty cash is a nominal amount of money readily accessible for paying expenses too small to merit writing a check or using a credit card. Company’s typically keep between $100-$500 on hand to pay for small transactions like office supplies or catered lunches.
A pitch competition is a business contest where entrepreneurs present their business concept to a panel of judges in hopes of securing cash prizes or investment capital. Popular pitch competitions include Y Combinator Demo Day, TechCrunch Disrupt, Hatch Pitch and Web Summit.
A pivot is essentially a shift in business strategy to test a new approach regarding a startup’s business model or product. Startup founders and operators may choose to pivot their business strategy to better accommodate the needs of their target audience, to break into a new vertical or industry, or to better optimize their business’s finances.
The term ‘portfolio company’ is used to describe a company in which an investor owns an ownership stake in it. Investors look to increase the value of their portfolio company to recapture and earn a return on their investment.
The term ‘post-money valuation’ refers to the worth of a company after it has completed a round of funding. The post-money valuation of a company is calculated by dividing the investment amount received by the equity (percentage) purchased by the investor. The post money valuation of a business is always higher than the pre-money valuation of a business.
The term ‘pre-money valuation’ refers to the value of a company prior to completing a round of funding. It gives investors an idea of the current value of the business and provides the value of each issued share. It is calculated by subtracting the investment amount from the post-money valuation. The pre-money valuation of a business is always lower than the post-money valuation.
Pre seed funding typically follows friends and family rounds. It refers to the initial round of "professional" equity capital into a business. Companies raising pre-seed funding sometimes do not have a product, or even have a prototype—sometimes all they have is an idea. While the amount of capital raised from this form of fundraising can vary, it's typically between $100-$500k.
The term ‘preferred equity’ refers to any class of securities (stock, limited liability units, limited partnership interests) that have a higher priority for distributions in a liquidity event or a dividend event (compared to common equity). Investors typically require their portfolio companies to have two classes of stock: common and preferred—they also require their equity be considered preferred.
A prepayment penalty is a fee that debt-financiers charge when the debtor pays off all or part of their loan early. This fee along with other applicable fees are outlined in the “Summary of Loan Documents”.
In a priced round, investors purchase stock in a company at an agreed-upon price per share. Priced rounds typically follow the issuance of a SAFE or a convertible note in a prior round, and are the most common investment structure in venture capital.
Principal refers to the amount of money that is borrowed through a loan—it generally needs to be paid back in accordance with the repayment terms and along with the predefined interest (whether variable or fixed).
The term ‘private placement memorandum’(PPM), also known as an offering memorandum or offering document, refers to the legal document that is provided to prospective investors when selling stock or other securities. The disclosures included in the PPM vary depending on the exemption from registration type, the target investors, and the complexity of the terms of the offering. The presentation of the PPM is more factual and concrete than a business plan and addresses external and internal risks facing the company. Well drafted PPMs balance disclosure requirements with marketing elements designed to seal the deal.
The term ‘pro-rata rights’ refers to a contractual provision that enables investors to maintain their equity stake and their voting power even when new shares are issued, without the obligation to invest in later rounds. It is typically given to early stage investors who are willing to start up at one of their riskiest points in time. If the investor declines their pro-rata rights and fails to invest in follow-on rounds, they will be diluted. Being able to maintain a consistent ownership percentage in a company can mean the difference between making thousands and millions of dollars for an investor, hence the importance to maintain and activate their pro-rata rights.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.
Product-market fit describes the degree to which a product satisfies the needs of a target audience. Companies with a strong product-market fit (and little competition) often have high margins because they do not need to spend time or financial resources educating or convincing the target audience that they actually need their product or service. Product market fit is less about hypothetical numbers, and more about an in-depth and tangible understanding of your customers, where they congregate and how they feel about your product or service. Achieving product market fit is crucial to escape the valley of death.
A profit and loss statement is a formal financial document that is used to show the revenues and expenses of a company during a particular period. Creditors and investors use the profit and loss statements of a company to evaluate its financial soundness and growth potential.
The term ‘profit margin’ refers to the percentage of profit that a company generates for each dollar of sales. Example: 20% profit margin means that the company generates $0.20 of profit for every dollar of products or services it sells. Software startups and SaaS startups typically have higher profit margins compared to businesses that sell physical products. Profit margins are used by creditors, and investors to determine a company's financial health, management's skill, and growth potential.
A projection is a type of estimate that is given to investors or potential financiers to explain the market opportunity, and revenue or growth potential that a startup has. Projections are typically based on the top-down or bottoms-up forecasting model, and are not intended to be used as KPIs.
There are five primary forms of projections including: sales projections, expense projections, balance sheet projections, income state projections, and cash flow projections.
The term ‘proof of concept’ refers to the process of determining the feasibility of an idea (in other words, the practical potential of a concept or theory)—it does not take into account the demand for such a product or service or the profitability of said product or service. Startups often undergo a few proof of concept exercises prior to launching out of stealth.
Protective provisions ‘protect’ an investor's rights such as their ability to veto a decision or action that they do not agree with—e.g. the issuance of more stock, the liquidation of the company, or the acquisition of the company. Protective provisions mitigate risk for investors and help protect the interests of minority shareholders in the event that there is a disagreement regarding the best course of action for the company.
Before you sign a term sheet it is imperative that you understand the protective provisions that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.
Prototyping is the action taken immediately following the proof of concept phase, where design teams transform an idea into a tangible item (whether physical or digital). Once the item is created, it is shown to individuals in the target market to gather feedback, so it can be refined. Prototyping is an iterative process of refinement and feedback. By prototyping, startups can avoid wasting time and resources building products or services that are not commercially viable.
The QSBS exemption is a tax exclusion in the IRS code that enables shareholders to sell or exchange their qualified stock, and receive a break on their capital gains tax—potentially up to a 100% exclusion of tax on the capital gains. To qualify for the QSBS exemption, the company you have equity in must be incorporated in the US, the company must have gross assets of $50 million or less (at all times before and immediately after the equity was issued) and the company must not be on the list of excluded business types.
For more information on the QSBS exemption and to determine if you are actually qualified, we strongly recommend you talk to a tax and financial advisor.
The term ‘full ratchet’ refers to the contractual provision that prevents the dilution of an early investor by future rounds of fundraising. It typically also provides protection against a drop in the strike price, should the pricing of future rounds be lower than that of the initial round. Full ratchet provisions can be extremely dangerous for early stage companies, as they force the company to continue to raise at higher rounds, while simultaneously not allowing the investor to be diluted.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want to have happen is you are raising a round of capital and the investor demands that they not be diluted or you have a down round and they expect their original shares to convert at the new (and lower) price.
The term ‘partial ratchet’, also known as a ‘weighted ratchet’ refers to the contractual provision that prevents the dilution of an early investor by future rounds of fundraising, and comes in two varieties: the narrow-based weighted average, and the broad-based weighted average. In either case, it takes into account the number of shares that are issued in the next dilutive financing round and the price is adjusted accordingly. The weighted/partial ratchet is a compromise to ensure that the early-stage investors maintain their benefits for getting in early, while simultaneously being a bit more friendly to the founders of the business.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.
The term ‘recapitalization’ refers to the process of restructuring a company's debt and equity stack, to stabilize their capital structure. It is typically invoked when there is a drop in a company’s share price, or when the company attempts to defend against a hostile takeover, or bankruptcy, and involves the exchange of one form of financing for another.
Receivables factoring, also known as accounts receivable factoring, is a type of alternative financing in which a company sells its receivables (invoices) to a third party at a discount to raise capital. It's similar to receivables financing, in that businesses can unlock capital today by tapping into their future accounts receivables, however, the key difference lies in the underwriting process and the collateral that is required.
Receivables financing is a form of non-dilutive funding that allows startups to collateralize their future accounts receivables to receive capital today. This type of financing can be used to fund operating expenses, hire new employees, expand into new markets, and much more.
The term ‘recurring revenue’ is related to the revenue model that a company employs for its products or services. When a product or service requires that it continually be paid for (such as a software subscription), it is said to generate recurring revenue for the business. Businesses that typically have a recurring revenue model include software startups and SaaS businesses.
Businesses that have a recurring revenue model are the perfect fit for revenue-based financing.
A recurring revenue loan is a type of debt-financing that is especially popular for software and SaaS businesses where they have a predictable stream of revenue. The loan amount is based on the size and nature (e.g. monthly or annual frequency) of the revenue stream. Recurring revenue loans are similar to revenue based financing (RBF) options, except that the receivables financing type of RBF is not considered a loan and does not carry interest.
Redemption rights give investors that hold preferred stock the right to require that a company repurchase their shares after a specified period of time. They are designed to protect investors when a company’s valuation is stagnant, and is no longer an attractive acquisition target or IPO candidate. While rarely included in a term sheet, they can represent a major problem to companies that do not intend to generate positive cash flows for some time and as a result will not be able to pay back the investor in the event they exercise their right.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want to have happen is an investor demands that you buy back their shares, and you don’t have enough capital to pay them back, or you have just enough capital to pay them back, but doing so will jeopardize your ongoing operations.
The term ‘refinancing’ refers to the ability of a financier to adjust the terms of a loan on the basis of a business's credit or repayment status/ The typical terms that are adjusted include the: interest rate (if fixed), payment schedule, and payment amount. Borrowers typically refinance when interest rates fall, or when they have a variable interest loan and rates are on the rise.
The term ‘registration right’ refers to the ability of an investor (who owns restricted stock) to require a company to go public so that the investor can sell their shares. There are two primary forms of registration rights: “piggyback”, which allow investors to have their shares included in a registration (IPO) that is currently in the planning stages by the company and “demand” which allow the investor to require a company to go public even if they’re not planning to do so in the near future.
Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want to have happen is an investor demands that you go public, and you are not ready or prepared to go public.
The repayment terms of a loan stipulate the time period in which the debt is required to be paid back, the fixed (or variable) payment amount, the interest (or discount) amount associated with the loan and any associated provisions related to the agreement.
The term ‘representations and warranties’ refers to the set of assurances given by both parties in an agreement. Representations and warranties are not required by law but are in nearly every purchase agreement of equity. The primary goal of representations and warranties is to transfer risk from the buyer to the seller, and vice versa.
The term ‘retention of title’ refers to the provision in a contract for the sale of goods, which enables the seller of the goods to maintain ownership of the goods (title) until the buyer fulfills their obligations, which can include the payment.
Revenue based financing is the friendliest way for startups to accelerate their growth, extend their runway and make strategic bets. It’s a type of business funding in which a company secures capital by selling rights to their future projected revenue streams at a discount. This is a win-win for both parties, as the startup receiving the capital can eliminate the time gap between customer-go-live and the eventual bump to their top-line revenue, and the financier generates a predictable return.
The two major types of revenue based financing are receivables financing and receivables factoring. The main difference being the sale of individual invoices (factoring) vs a cash advance on future projected revenue streams (financing).
For a more in depth look at revenue based financing, including the qualifications, top providers and frequently asked questions, check out the comprehensive guide we put together.
A revenue sharing note (RSN) is an agreement, in which a company borrows money from an investor and agrees to pay back a certain percentage of their revenue every quarter until all of the principal and accrued interest from the loan is paid back. The four major things that should be considered prior to signing a RSN agreement include the: investment multiple, maturity date, revenue share percent, and internal rate of return. It functions similarly to a revenue based financing agreement, except that the rate of repayment is not fixed—in periods of lower revenue, you pay a lower amount and in periods of higher revenue you pay a higher amount.
For high-growth startups this fluctuation in payment amounts is often challenging, because they cannot fully leverage the additional revenue they generate to further increase their growth rate.
The term ‘right of first refusal’, also known as a “preemptive right” refers to the ability of an investor to take the first “at bat” in the event of a potential liquidation event, sale of equity or other relevant trigger. For example the right of first refusal related to the sale of equity would give an investor the right to purchase (or pass) on the shares being offered by a shareholder, before anyone else gets the same opportunity. In the event of a liquidation event, it would give the investor the right to purchase (or pass) on the outright sale of the company and its assets. Typically the right of first refusal is included in the provisions of the term sheet that is provided to the business receiving the investment.
The term ‘right to audit’ refers to an investor's (or board member’s) right (but not obligation) to audit the books, balance sheet, user base, code base or other centralized record of their portfolio companies’ that is directly related to its business operations and performance. Typically the right to audit is included in the provisions of the term sheet that is provided to the business receiving the investment. A recent example of an investor leveraging the right to audit, is Elon Musk who requested access to the user logs of Twitter to determine how many actual fake and spam accounts there are (compared to the 5% they reported).
The term run rate refers to the financial performance of a company based on its current business fundamentals, and is used to predict its future performance with the assumption that market conditions remain constant. For example, if a company has generated $50 million in revenue each quarter for the past three quarters, the run rate for the following quarter would be estimated at $50 million, and the annual revenue run rate would be estimated at $200 million.
Calculating the run rate of an organization is a more accurate form of forecasting compared to the bottoms-up and top-down forecasting methods. It is particularly useful for estimating the performance of companies or departments that have been operating for less than a year.
While the run rate of a mature business is relatively consistent, for seasonal businesses or businesses whose sales are highly dependent on the economic landscape (such as the travel or luxury clothing industry) it can be highly inaccurate.
Runway refers to the period of time that a startup can “survive” or continue operations based on its monthly cash burn and its cash in the bank. The shorter the runway a startup has, and the higher the burn it has, the more likely it is to go bankrupt. During periods of economic expansion, the burn rate a company has doesn’t matter as much as its growth rate, as investors are willing to fund companies that are growing exponentially. During periods of economic compression, investors are much more stringent on a company’s cash burn and growth rate, often suggesting that company’s conserve their cash and cut back on their growth plans to extend their runway. A company has an infinite runway when it surpasses the break even point—i.e. when its revenues exceed its expenses.
A SAFE note is a form of financing used by early-stage startups (typically seed stage) to raise capital from investors. They are short five-page documents with standard, non-negotiable terms (other than the valuation cap). Like options or warrants, they allow investors to buy shares in a future priced round at a discount, however, unlike convertible notes, they are not debt and do not accrue interest.
Scalability refers to the relative ability of a business to scale its operations. The scalability of a business directly affects its valuation, because it is related to how fast and how profitable it can be given the right market conditions. The more scalable a business’s model is, the more it is worth. Software startups and SaaS startups with asset-lite business models are often the highest valued companies because they can essentially scale indefinitely without inventory, physical assets, or intense amounts of labor.
A secretary’s certificate is exactly what it sounds like: a certificate signed by the secretary of a company—that is delivered at the closing of a transaction. It typically contains the following information: certified copies of the organizational documents of the company, certified copies of the authorizing resolutions for the transaction, statements to the incumbency of all individuals executing the operative agreements, and all other necessary documents.
The Securities and Exchange Commission (SEC) is an independent governing body that oversees the rules and regulations related to the purchase, sale or transfer of securities in the US. The primary goal of the SEC is to enforce laws against market manipulation.
Securities law compliance refers to the adherence of the rules and regulations provided by the U.S. Securities and Exchange Commission (SEC) Financial Industry Regulatory Authority (FINRA). The penalties for violating securities laws range from time in prison to large monetary fines.
Seed funding is typically the first official round of equity funding into a business (preceded occasionally by a pre-seed round). Seed funding is leveraged by companies to finance their first round of market research and product development, along with the hiring of a couple of key individuals. The typical investors of a seed round include: friends, family, incubators (like YCombinator), and angel groups and angel syndicates. The typical amount of seed funding ranges from $25,000-$2 million (the medium was $1 million in 2020), at a valuation between $3-6 million.
Senior creditor refers to a financier that is paid back first in the event of a bankruptcy, followed by junior or subordinated debt holders or hybrid debt holders (e.g. convertible notes), preferred shareholders and lastly common shareholders. Senior creditors are often bondholders or banks that have revolving credit lines, and typically require a lien against a company’s collateral to secure the credit facility.
Senior debt, also known as senior notes or senior loans refers to a form of debt financing that is repaid first in the event of bankruptcy, followed by junior or subordinated debt holders or hybrid debt holders (e.g. convertible notes), preferred shareholders, and lastly common shareholders. Senior debt typically requires a lien against a startup's assets or collateral, and a personal guarantee from the founders of said startup to secure the capital.
Serviceable available market (SAM) refers to the portion of a company’s TAM that is targeted by a company’s products and services, and is within its geographical reach. The SAM of a business is always smaller than its TAM, and larger than its serviceable obtainable market (SOM).
Serviceable obtainable market (SOM) refers to the portion of a company’s SAM that can be reasonably expected to be captured. The SOM of a business is always smaller than its SAM and
A shareholders agreement is a pre-arranged document that outlines how the company will operate, and the rights and obligations that the shareholders of the company have. The purpose of this document is to ensure that shareholders are treated fairly and that their rights are protected. It typically includes: the number of shares issued; a cap table; any restrictions on transferring shares; pre-emptive rights; and payments details in the event of an exit. Shareholders' agreements are optional and are most helpful when an organization has a small number of active shareholders.
A silent partner is an investor who shares in a startup’s profits and losses but is not involved in the day to day operations or management of the business. Typically a startup’s pre-seed and seed investors, such as angel groups or angel syndicates, are silent partners. But as a startup matures and raises additional rounds of funding, the investors become active partners, occasionally through a seat on the company’s board of directors.
Single-entry bookkeeping refers to a method of accounting in which each transaction is recorded as a single-entry in a journal. The cash-based bookkeeping method tracks incoming and outgoing cash for a business, leading to a cash balance at the end of a period. Typical cash books include the following for each transaction: date, description, value, cash on hand. A great example of single entry bookkeeping, is the daily activity of balancing your physical checkbook (assuming you still have one).
Small business association loans range from $500 to $5.5 million and can be used for most business purposes, including the purchase of long-term fixed assets and working capital. SBA loans come with a few benefits including: competitive terms, counseling and education, lower down payments, flexible overhead requirements, and no collateral requirements. There are three main types of SBA loans: 7(a) loans, 504 loans and microloans.
The small business association (SBA) is a governmental organization that helps small businesses through capital injections (loans), guidance, counseling and mentorship, and contractual expertise. Often the SBA works with local chambers of commerce to connect new business operators with established business operators in the community. The SBA works to ignite change and spark action so small businesses can confidently start, grow, expand, or recover.
The small business innovation research program is run by the SBA with the intent to help small businesses conduct research and development through contracts and grant funding.
Soft landings, like acqui-hires, are the result of an acquisition. Unlike an acqui-hire though, in the event of a soft landing, the investors of the company basically get no money back. The goal is to “softly land” the employees and the assets, as the only other option is bankruptcy. Soft landings are sometimes the result of vulture capital.
Software as a service (SaaS) refers to a business model in which a company sells cloud-based software (accessed via a browser or mobile app) at a monthly or annual fee. SaaS businesses are typically asset-lite, have high gross-margins, and are highly scalable. Examples of SaaS businesses include: Hubspot, Salesforce, Cloudflare, and Meta (Facebook). Most businesses that have a SaaS business model are a perfect fit for revenue based financing.
A software startup, is a business that develops, sells and distributes different types of software. They often have a SaaS business model, but occasionally have hardware components too. Examples of well-known software companies include Apple, Tesla, Google, and Dropbox. Software startups are a great fit for revenue based financing.
A stand-alone convertible note is intended for use by early-stage startups looking to raise seed capital from angel investors, friends, and family before receiving institutional funding from a venture capital firm. It contains all the terms of the agreement, including the borrowing mechanics, remedy in event of default, and valuation cap (if applicable).
A startup advisor is a subject-matter expert who provides industry or subject matter guidance and mentoring. They are typically well connected to investors and other industry professionals, to whom they provide warm introductions.
Advisors are usually compensated for their efforts either monetarily or through equity grants—ranging from 0.05% up to 1%. The ideal time to bring on an advisor is when you’re hiring key staff, pursuing strategic partnerships or ramping your sales.
Avoid bringing on an advisor who has:
- No interest in your business or your mission
- Minimal free time because they are overcommitted to other startups
- A conflict of interest (i.e. advises a similar company in your industry)
Startup capital refers to any cash injection in an early stage business—typically the initial pre-seed round of a business is funded by friends and family, an angel group or an angel syndicate. As the startup matures, and offers additional rounds of funding venture capital funds and private equity funds invest. If the startup generates recurring revenues, another non-dilutive option to raise capital is revenue based financing.
An incubator is an organization that provides mentorship, early funding, working space, and connections to help entrepreneurs grow their businesses and develop a minimum-viable product. Well-known incubators include Idealab, The Batchery, Upward, SteelBridge Laboratories, and Invenshure.
Stock purchase agreement (SPA) refers to a contract between two parties, where a buyer purchases shares (or equity) directly from a shareholder. The contract is considered binding only if it aligns with all federal, state, and local laws, outlines the benefits received by both parties, and if both parties have capacity to enter into the agreement.
The term “strategic investor” refers to an individual or group that offers more than just money to a startup, which can include: industry expertise, connections with other industry operators or investors, or support on marketing, sales, design…etc.. Typically startups should have one or two strategic investors each round to make sure they’re maximizing the value of their cap table.
A word of caution—if you are going to take on a strategic investor, make sure they didn’t include any unique controls or rights in their term sheet outside of those granted to your other investors such as a Right of First Refusal.
Strike price refers to the dollar amount that an individual or organization needs to pay to exercise their stock option, and is calculated based on the 409(a) valuation of the company. The strike price an employee pays is outlined in their stock option grant, which outlines the number of shares they are entitled to purchase, the vesting schedule, and the price they need to pay to purchase the shares (strike price). The strike price paid for a single option grant remains the same regardless of its exercise date, even if the company’s value increases significantly.
Success fee refers to the compensation that is paid to an investment bank (ibank) for successfully closing a transaction, in a merger or acquisition it is calculated based on a company's enterprise value, and is contingent on the completion of the deal. Success fees align the interests of the company and the investment bank processing the transaction, and incentivize the ibank to get the best deal possible. They also typically have a simple fee structure that makes it easy to understand.
Sweat equity refers to the exchange of expertise, labor and time, for discounted equity in the business. Founders and early employees often earn sweat equity when bootstrapping their business, due to the lack of available financial resources.
Target rate of return refers to a dollar figure (profit) that an investor wants to see based on their investment in a company, adjusted for the time value of money (TVM). Investors work backward from their ideal return on investment to determine their target price for the investment.
A tender offer is similar to a takeover bid, in that an individual or organization offers to purchase some or all of the outstanding shares of a company’s stock. The offer outlines a specific price (typically at a premium compared to the current strike price) and a specific time period—it is usually contingent on a minimum or a maximum number of shares being sold.
A term loan is a form of debt that is repaid in regular payments over a set period of time. Term loans are typically the simplest form of loans available and are accompanied by either a variable interest rate or a fixed interest rate. There are three primary forms of term loans, short-term, intermediate-term and long-term loans—the longer the term, the higher the interest rate charged.
If you’re considering a term loan, revenue based financing may also be a good alternative.
A term sheet is a nonbinding (sometimes binding) agreement that outlines the financial terms and conditions of an investment, acquisition or business agreement. It opens up future negotiations between two parties, lays out the financial terms of the investment, it plainly states how much the startup is “worth”, and outlines the various provisions or requirements that accompany the investment.
Before signing a term sheet, discuss it with your legal council so that you understand the outlined provisions and their potential implications. Some of the particular provisions to pay attention to include: pay-out provisions, liquidation preferences, option pools and board seat requirements.
Terminal value refers to the value of an asset, business, or product beyond the forecasted period. It is useful when creating financial models, more specifically discounted cash flow valuations. The two most common forms of forecasting used to determine a businesses terminal value include: the perpetual growth model and the exit multiple model. It is possible to achieve negative terminal value if the cost of future capital exceeds the assumed growth rate, but is not sustainable.
Here’s a helpful tool that visualizes the impact of your burn and growth rate on your terminal value, profitability, and break even point.
A 409A valuation is an appraisal of the fair market value (FMV) of the common stock of a private company by an independent third party. Startups typically get their initial 409A valuation before they issue their first common stock options, and after raising a round of equity financing. They typically also request a 409A valuation upon receipt of an acquisition offer. Startups use the findings from a 409A valuation to inform the price at which employees can purchase shares of the company's common stock. A few of the more frequently used independent third parties for conducting a 409A valuation include: Kruz Consulting, Carta, and Shareworks.
504 loans are a form of fixed rate financing that is offered by the Small Business Association (SBA). The maximum amount offered is $5 million, and is typically used for business growth and job creation. It cannot be used for working capital or to consolidate or refinance current debts. To qualify for a 504 loan, the organization must operate as a for-profit company in the USA, have a tangible net worth of less than $15 million and have an average net income of less than $5 million.
For more information on 504 loans, visit the SBA website.
7(a) Loans are offered by the Small Business Association (SBA), and are the most commonly offered loans by the SBA. The maximum amount offered is $5 million, and it is typically used for short-and long-term working capital, to refinance current debt, and to purchase assets/supplies. To qualify for a 7(a) loan, the business must be considered a small business, must operate in the USA, prove they actually need the loan and operate as a for-profit business.
For more information on 7(a) loans, visit the SBA website.
Simply put, an 83(b) election is a document that you send to the IRS that informs them of your intention to be taxed on the date your equity was granted rather than on the date the equity vests. Typically 83(b) elections are made by early employees or startup founders who have the ability to early exercise their options.
Top-down forecasting, in contrast to “bottoms-up forecasting”, refers to the method of estimating future performance by starting with high-level market data, such as the TAM of a business, and working down to your estimated market share to determine projected revenues for the coming year.
Early stage startups typically use top-down forecasting when they don’t have any hard metrics (e.g. revenue, customer lifetime value, churn). As they mature, they transition from the top-down model to the bottoms-up model mentioned above.
The total addressable market (TAM) refers to the overall revenue opportunity for a company if 100% of the target audience purchased their product or service. It is useful for early-stage startups when forecasting future revenues using the top-down method and for prioritizing specific products, customer segments, and business opportunities. It becomes less useful as an organization matures and gathers hard data around its true market opportunity.
Trajectory growth funding, like traditional growth funding, is provided to startups who have demonstrated significant growth over the trailing 3-6months. It is typically equity capital, but can also be non-dilutive debt capital. Funding amounts usually range from $100,000 - $5 million, but can be significantly more. In recent years, startups seeking trajectory growth capital have sought out providers of revenue based financing to fuel their growth.
An underwriter is an individual whose responsibility it is to assess, evaluate and build the risk profile of companies during the underwriting process.
Underwriting refers to the process of evaluating the risk profile of a company based on its fundamentals. The result is oftentimes an offer to provide funding to said organization under certain payback conditions. Startups typically undergo underwriting when they are raising debt capital.
Underwriting fees are charges provided by a financier to a company for underwriting their business—they can range anywhere from a few hundred, to a few thousand dollars.
The use of proceeds document outlines the plan in which a company intends to acquire and deploy new capital injections. Typically it is broken out by functional area/purpose, which is accompanied by a %: e.g. spend 20% of capital to increase headcount by XX, deploy 50% of capital to develop YY product, utilize 30% of capital to launch ZZ marketing campaign.
The valley of death, refers to the point in time in which an early stage company has begun operations, but has not yet generated revenue—resulting in the depletion of the initial equity capital received from investors. Surviving the death valley curve requires that the startup either:
- Generates sufficient revenues to become self-sustainable
- Raised significant capital, is growing rapidly and plans to raise more capital soon
- Has access to more lines of credit or capital to fund their operations
Startup valuation refers to the value of an early stage company taking into account market forces. In periods of economic expansion valuations are stretched, in periods of economic compression valuations are squeezed. Factors that can affect a company's valuation include their: traction, growth rate, revenue, leadership team, industry and competition. In 2022, late stage startup valuations are being slashed almost daily, e.g. instacart, Dbt Labs…etc.
A valuation cap refers to the point in time at which an investor can convert their SAFE into equity in the business, and is based on either a valuation or price target. It “caps” the conversion price of the issued shares and ensures that early investors receive an immediate upside on their equity purchase.
Early stage startups leverage valuation caps to incentive their seed stage investors to take on additional risk. The lower the valuation cap, the larger the percentage of equity the investor will get.
For example, if the current price per share is $5 and the SAFE has a 50% discount, the investors would convert it into shares at $2.50 so that they recognize an increase in value of $2.50 on paper.
Valuation divergence refers to the difference between the growth rate of a company's valuation and the valuation of the shares that investors received. It can be due to a number of factors including: dilution by subsequent investors, and the exchange of a convertible note for equity. Valuation divergence is common in high growth companies and typically ranges from 3-5x.
Variable interest, also known as “floating interest” is a type of interest on a loan that fluctuates over time, due to its nature of being based on an underlying benchmark interest rate or index. Loans with a variable rate are like a double edged sword—they benefit from lower payments when the underlying interest rate market is in decline, but when rates rise the monthly payments spike.
For early-stage companies, when funds are tight, fixed interest loans or revenue based financing options are much more appropriate, because they limit the risk of defaulting.
Venture Capital (VC), not to be confused with Vulture Capital, is a form of private equity that seeks to fund the growth of early stage organizations. Venture capitalists typically also provide financial, legal, technical or managerial assistance, along with warm introductions to early customers and later stage investors when the company has demonstrated a high growth potential. VC funds typically consist of individual investors, investor groups, investment banks and other financial institutions.
Venture debt is a form of debt financing provided to venture-backed companies to fund working capital or capital expenses, such as purchasing equipment. It typically needs to be repaid within three to four years, and often starts out with a 6-12-month interest-only period. Venture debt products typically also come with personal guarantees, covenants, warrants, and other restrictive terms designed to benefit the financier. Some of the most common venture debt providers include: Silicon Valley Bank, and Hercules Capital.
For a more in-depth look at venture debt, check out the comprehensive guide we put together.
A vesting schedule outlines the fixed period in which employees vest their shares, or in other words unlock the right to purchase a portion of their equity. Most vesting schedules for an early-stage startup are four years, with a one year cliff, and monthly vesting after the cliff.
In this example, the employee “unlocks” 1/4th of their stock after one year, and 1/48 of their stock each month thereafter. If they leave after 1.5 years, they have unlocked the ability to purchase 9/24ths of their stock, and forfeit their unvested shares.
In recent times, Coinbase, Lyft and Stripe have reevaluated the traditional approach and have offered their employees a one-year vesting schedule. We expect this trend to continue.
Veto rights give a company’s board of directors the right to refuse to approve a proposal, thus preventing its enactment. A few potential scenarios in which a veto might be leveraged include:
- A proposal increase or decrease the amount of preferred or common stock
- The creation of any new series or class of shares
- The acquisition of another organization
- The sale, dissolution, or liquidation of the company
When negotiating term sheets it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want is to have a buyer lined up for your company, or have an acquisition that you want to complete, and the board vetoes you.
A voluntary conversion is the exchange of a convertible type of asset, such as a convertible note, into another type of asset—usually at a predetermined price—on or before a predetermined date. It is voluntary, because the holder of the convertible type of asset has the ability, but not obligation to, execute the exchange.
Voting rights give board members the right to vote on topics discussed in board meetings, such as a funding round, the issuance of new stock, the initiation of mergers and acquisitions and more. Without voting rights, a board member has no say in the direction of the business or the residing management team.
A vulture capitalist is a type of investor that invests in or purchases distressed companies for profit. They typically purchase companies that generate revenue, but are on the verge of bankruptcy due to mismanagement and overspending. Once acquired, they start cutting costs through layoffs, a reduction in benefits, and a sale of exorbitant assets. Occasionally they also split off divisions of the business to recoup their initial investment and minimize their risk.
Warrants give the holder the right (but not the obligation) to purchase stock at a specified price within a specific period of time. They are often used by banks, providers of venture debt and venture capitalists to mitigate their risk and maximize their upside. There are three components of a warrant: the number of shares, the strike price and the expiry date. The terms of a warrant are negotiated based on the risk/return profile of the deal—most warrants translate to 1-2% of the company when executed, but some warrants have been converted to 20%+.
Warrant coverage is an agreement between a company and an investor, where the company issues a warrant to the investor allowing them to acquire shares at a predetermined price. The holder of a warrant coverage has the right, but not obligation to, buy the additional shares of stock. Warrant coverage is typically issued in situations when a higher-than-normal level of risk is present.
There are many reasons why companies offer warrant coverage, the two most significant are to attract more investors and ensure the maximum participation by committed investors.
Waterfall equity is the primary method used to distribute the equity gained from a group or pooled investment (e.g. angel group, angel syndicate, private equity…etc.) The distribution is aligned to the pecking order in which the largest investors, or limited and general partners are granted the largest portion. As a result, they also receive a disproportionately larger share of the total profits relative to their initial investment once an exit event occurs.
Wire transfers, like ACH payments, are a form of electronic transfers from one person or entity to another. They are typically used because they are quick and cheap, as the recipient can access the funds immediately (there are no bank holds).
Working capital is a dollar figure calculated by subtracting a company’s current liabilities, such as accounts payable and debts, from their current assets—such as cash, and accounts receivable. It is used to pay short-term debts, and day-to-day operating expenses.
An X-mark signature is used by an individual who is unable to append their full signature due to illiteracy, disability or another impediment. It is only considered legally valid, if it is witnessed.
Yield is the income returned on an investment by an investor or financier, it’s the same amount as the interest (or discount) paid on a loan. Yield is typically expressed as an annual percentage rate based on the loan's cost, current value, or face value. The higher the yield on an investment, the higher the interest (or discount) paid on an investment is.
Yield advantage equals the difference between the rates of return (yield) on two different securities issued by the same company, e.g. convertible notes vs common stock.
The yield basis is a dollar figure calculated by dividing the principal paid annually. It is quoted as a yield percentage, rather than as a dollar value. It allows bonds (or loans) with varying characteristics to be easily compared.
The yield curve is a chart that depicts how the yields on debt instruments vary as a function of their payback term to maturity. It is used to compare the interest rates (yield) of debt instruments that have equal credit quality but differing maturity dates. There are three main types: normal (upward sloping curve), inverted (downward sloping curve), and flat.
The yield spread represents the difference between the yields on differing debt instruments of varying maturities, credit ratings, and risk levels. It is calculated by deducting the yield of one instrument from another and is typically expressed in basis points (bps).
A Z-tranche is the lowest ranked portion of a split-investment that is paid off only when all the other senior tranches (aka installments) have been satisfied. A z-tranche comes with pre negotiated payment terms and enables investors to get equity in a company at the lower pre-money valuation when they made their initial investment. It also enables investors to gain more equity in the business because their staggered tranches are not self-diluting.
A zero balance account (ZBA) is an account in which a balance of $0 is maintained. It is intentionally kept at $0 to maintain greater control over the disbursement of funds and to minimize the risk of fraud. When funds are needed, money is transferred from a central account. ZBAs are typically used to cover payroll, petty cash and other similar needs.
Zero-based budgeting (ZBB) is a budgeting approach that entails developing a new budget from scratch every period. It ensures that managers think through every dollar they plan to spend, their operating expenses and the areas in which the company is generating revenue. Walgreens, Philip Morris, Unilever, and many others take a zero-based budgeting approach.
A zombie bank is a financial institution that continues to operate despite its liabilities exceeding its assets, its inability to service its loans. It continues its operations through governmental support.
Zombie companies, also known as zombie firms, are organizations that continue operating despite its liabilities exceeding its assets, its inability to service its loans, or its ability to repay the interest on its debts but not the principal. Zombie firms are not common in the US, but they are present—mostly in the manufacturing and retail sectors. They typically rise in periods of economic compression, and fall during periods of economic expansion, and take bailouts in order to continue their operations.
Zombie companies, also known as zombie firms, are organizations that continue operating despite its liabilities exceeding its assets, its inability to service its loans, or its ability to repay the interest on its debts but not the principal. Zombie firms are not common in the US, but they are present—mostly in the manufacturing and retail sectors. They typically rise in periods of economic compression, and fall during periods of economic expansion, and take bailouts in order to continue their operations.