VENTURE CAPITAL TERMS
Below is a collection of terms that everyone involved in the venture capital world should know: some are well known investments terms, others are just catching on. Whether you’re an entrepreneur, a startup employee, or a seasoned investor who needs needs to fill in some knowledge gaps, this glossary is for you.
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Accelerator - the speed ramp that takes startups from adolescence to something resembling early adulthood. Accelerator programs typically last three to six months (as opposed to incubators, which have longer time spans) and are meant to help startups that are already performing scale up and create the organizational framework that they’ll need to thrive.
Accredited Investor - a wealthy investor who meets certain SEC requirements for net worth and income.
Angel Investor - an accredited investor who invests their own money in a startup. They operate solo or in smaller groups (as opposed to larger VCs) and usually focus on early-stage startups.
Antidilution - defense against dilution: these provisions are designed to protect investors by issuing them additional shares in future funding rounds or by lowering the conversion price for their preferred shares, thus giving them more common shares.
Assets Under Management - the VC is the management, and they’re sitting on top of a whole pile of money; this is the money that they have available for venture investments.
Benchmark - performance goals against which startups are measured if they want more investment money. These include things like revenue and market penetration.
Blind Pool - a form of limited partnership that doesn’t specify what type of investments if will pursue.
Board of Directors - the people calling the shots, broadly speaking. Startup founders should be on the board, plus the VCs that fund fund them often get a seat too (especially the lead investor).
Board-Observer Rights - even if they don’t get a vote, this person sits on the board and observes. They lean back, letting the founders do what they’re going to do, and guide the conversation when necessary. They might not be able to vote, but they can still influence events (plus, everything they “observe” goes back to the VC).
Bootstrapped - starting a business with money and resources from the founders’ own pockets.
Bridge Loan - a short-term infusion of cash designed to keep you afloat until longer-term financing can be arranged. Sometimes raised during a “bridge round” (even though bridge rounds don’t necessarily have to include debt). This kind of funding has gotten increasingly complicated recently. It generally signals that things aren’t going that great for a startup.
Burn Rate - the rate at which a business spends money (especially VC money) in excess of revenue.
Buyout - purchasing a company or a controlling interest of a corporation’s shares, product line, or some business.
Cap Table - a table providing an analysis of the founders' and investors' percentage of ownership, equity dilution, and value of equity in each round of investment.
Capital Efficiency - the relationship between how many expenses are incurred by the company to how much money is used to manufacture a good or service. Basically, how far is an investor’s money going? It can also mean how efficiently the capital was used in terms of an exit. Ex.: raising $10M and exiting for $100M (10x) is more efficient than raising $20M and exiting for $150M (7.5x).
Capped Note - places a cap on the value of the company at which an investor’s debt converts to equity. Ex: a $500,000 investment translates to a 10% stake in a company with a cap of $5M.
Capped Participation - the middle ground between participating preferred stock and non-participating preferred stock: it allows for double dipping, but only to a point. The VC is entitled to a share of the leftovers after their liquidity preference amount has been satisfied during a liquidity event, but that share is capped (or they can convert their PP shares to common shares). Example: if a VC has a 3x cap, then they get their 1x liquidation preference (basically breaking even), then up to 2x of the leftover cash (so whatever cash is left over after that goes to someone else).
Cash Position - a combination of actual cash on hand and highly liquid assets such as CDs, short-term government debt, and other cash equivalents.
Closing - this is when all the contracts and agreements in question are signed.
Common Stock - just good old equity in a company; these shares don’t get to vote like preferred stockholders do.
Conversion - turning preferred stock into common stock.
Convertible Debt - this is a way to raise capital while delaying valuation: these notes convert into equity at a later date (usually a later round of funding) and the investors who invest at this time usually get a warrant (discount) on future stock as a reward for investing at this risky time.
Convertible Stock - this is the ability for preferred stock to transform into common stock, usually at a 1:1 ratio.
Corporate VC - corporate VCs are specialized subsidiaries within corporations with a mission to spread their cash around. Some investments are strategic (“Hey, we do similar things, let’s work together…”) or purely financial (“That idea isn’t really in our wheelhouse, but it looks like it’s going to make money, so we want in”), or a blend. Startups can also profit from the corporation’s experience and other resources (see value adds).
Crossover Investors - an investor who invests before, during, and after a company's IPO.
Deal Flow - the rate at which VCs discover new deals. VCs sift through tons of deals (sometimes over 1,000 per year), outright rejecting many of them, eliminating others through research, and finally seriously pursuing about 1% of all deals that cross their desks.
Debt Financing - selling debt to raise money. Basically taking out a loan, but instead of going through a bank, one goes through a VC.
Dilution - just what it sounds like: before a round of funding, the founders or investors owned more of a company than after the round. Example: a founder started off with 50% ownership, then after the round, only owns 40%.
Disruption - originally coined by Harvard professor Clayton M. Christensen, it’s when an innovation transforms an existing market or sector by introducing simplicity, convenience, accessibility, and affordability where complication and high cost are the status quo.
Direct Financing - financing without an underwriter, typically the province of investment banks.
Down Round - it’s when a startup does another funding round, but instead of selling each new share for more than the per-share price of the previous round, they go for less. Usually, this means that the company’s not doing that well. Sub-optimal, but sometimes companies have to do a down round to raise some capital. (See full ratchet.)
Due Diligence - the business equivalent of a full-body search. Founders hand over a business plan, financials, team information, and more.
Employee Option Pool - the available stock that founders can award to employees in the form of options (i.e. the ability to buy shares at a pre-set price). These options vest over time, so that employees accumulate them gradually and are incentivized to remain at a growing company. If the company is doing well, the underlying stock will rise in value even as the strike price remains the same, and so the options will be more valuable.
Entrepreneur in Residence - sometimes this is a seasoned entrepreneur at a VC who they rely upon to pick winning ideas or companies, other times it can just be a big name that’s associated with a fund for (largely) cosmetic purposes.
Equity - equity investments pay for partial ownership of a company. Stock, essentially.
Exit - the sale or exchange of a company ownership for cash, debt, or equity.
First-Mover Advantage - FMA - the advantage of getting into a market first and getting a big share of the customers.
First-Round Financing - the first investment in a company made by outside investors.
Follow-on Investments - think of this as doubling down on a good bet: people who invested in a company already throw in more money for another round.
“Friends and Family Round” - a form of seed round wherein founders get their friends and family to give them money in the hopes that the stock that they’re receiving will one day be worth money. (Sometimes called the “three fs” - friends, family, and fools, because investing in an unproven idea is so risky.)
Full Ratchet - a form of antidilution protection that sets the conversion price for preferred stock in relation to the price of a new round of shares, regardless of how many new shares are issued. Ex.: If there were 100 shares of stock issued during the first round at $1 per share, even if the company only issues 10 more shares during the next round, but they do it at 50 cents per share (this would be a down round), then the new conversion price is 50 cents. Compare with weighted average.
Fund of Funds - these are larger institutional platforms that invest in many different funds. This allows institutional investors to get allocations in some funds that, they perhaps otherwise wouldn't be able to.
Gamification - the process of adding game-like elements (points, perks, power ups, etc.) to other activities to drive engagement.
General Partner - a partner in a VC firm who is commonly a managing partner and active in the day-to-day operations of the business. They convince limited partners to add their money to the fund and then invest that money for them.
Growth Equity - typically a private equity investment, usually a minority investment, in a relatively mature company that is looking for capital to expand or restructure operations, enter new markets, or finance a significant acquisition without a change of control of the business.
Incubator - offices that bringing together seasoned and rookie entrepreneurs of all kinds to help each other grow. They give startups the resources that they need to succeed: a place to sit and meet with clients, networking opportunities, office support, stuff like that.
Internal Rate of Return - (sometimes referred to as “IRR”) how GPs let their investors (LPs) know how well their investments are doing
IPO - Initial Public Offering - when a company’s shares are offered for the first time on a public market. There tends to be a lot of cash infused into a company all at once.
Lead Investor - usually the investor putting the most money into a company during a given round of financing. They also help negotiate and set terms and often take a seat on the board.
Leveraged buyout - acquiring a company with mostly debt and a little bit of equity. The debt is secured by the assets of the business doing the acquiring. They use their own collateral for the loan in the hopes that future cash flow will cover the loan payments.
Limited Partner - (LPs) the investors who add their money to a VC fund and let General Partners invest that money for them.
Liquidation - selling off all of a portfolio company’s assets; compare to (but not to be confused with) a liquidity event.
Liquidation Preference - these provisions help insure that a VC gets paid first in relation to their investments. Usually the VC gets a 1x multiple for their liquidation preference (which means that they’ll at least get their money back), but they can push for more if they want, though that creates what's known as a waterfall effect where common stock (owned by founders and employees) has to wait in line to receive their shares until all the liquidation preferences are honored.
Liquidation Preference Stacking - this gives participants in later (higher-value) investment rounds preference in getting paid back in the case of a liquidity event. Shouldn’t the first folks to throw in get paid back first? Well, you’d think so, but odds are that investors put in less money during the first round than those later investors, so they get paid back first.
Liquidity Event - an event that converts illiquid assets (stocks, usually) into cash. The most common ones (and best, from a founder’s point of view) are IPOs, mergers, and acquisitions.
Lock-up Period - this is the period that an investor must wait before selling or trading shares subsequent to an exit event.
Master Limited Partnership - a limited partnership that is publicly traded, combining the tax benefits of a limited partnership with the liquidity of publicly-traded securities.
Merger - when two companies decide to come together into one company. This can be to acquire new talent, technology, or market share.
Mezzanine Debt - debt that incorporates equity-based options (like warrants) with lower-priority debts (remember, debt usually gets paid off first, before equity, but with lower returns). This kind of debt is actually closer to equity than debt.
Mezzanine Financing - usually the last stage of funding before a company has their IPO, usually structured to be repaid after said IPO.
Micro VCs - micro-VCs are smaller venture firms that primarily invest in seed stage emerging growth companies, often have a fund size of less than $50M and may invest between $25,000 and $500,000 in a given company.
Monetize - to get paid for something. If a company offers a free software as a service trial, then converts those users to paid users, they’re now monetized. Things like sponsored tweets or other content also count as monetization.
Non-Participating Preferred Stock - in a liquidity event, VCs get to choose either their liquidation preference amount (1x, 2x, etc. whatever they already agreed upon) OR they can take the value of converting all their NPP stock to common stock, just as they would with any form of preferred stock. Compare to Participating Prefered Stock.
Paas - Platform as a Service - cloud computing. The company gives the client the ability to develop, run, and manage a web application (without all the infrastructure that usually goes with that) and charge them.
Pari Passu - it’s not French, it’s Latin, and it means everyone gets treated the same in a liquidity event, it’s basically the opposite of having a liquidation preference.
Participating Preferred Stock - this kind of stock lets the VC do a little double-dipping: basically, in the case of a liquidity event, they get some more money after their initial payout. Example: if a VC owns 20% PP stock in a company and it’s liquidated, they get paid out for their stock, then they get 20% of any leftover cash after all the other investors have been paid out.
Party Round - a round of financing where generally a small amount of money is raised from a large number of investors (commonly between 10 and 20).
Pay-to-Play - even though the pro-rata right guarantees investors the chance to maintain their ownership percentage, they still have to pay for it. This full-on requires a VC to keep investing in future rounds to keep from being diluted (see “follow on” and “signalling risk”).
Piggy Round - when a larger early-stage or multistage fund offers to do 80-100% of a company’s seed round
Pitch - a gutsy, heartfelt attempt to make a VC pry open its purse. The startup team will put together a comprehensive presentation (a “deck”) and reports to show the VC that they are a good investment. They’ll physically go to the VC’s offices, present the deck, and take questions.
Pivot - when a business plan doesn’t work, the company changes things up.
Post-Money Valuation - the value of a company after investment. (Technically this = pre-money valuation + amount of funding raised.)
Pre-Money Valuation - the value of a company before investment.
Preferred Stock (Preferential Shares) - stock in a company that has additional rights, most commonly voting rights. Can be converted into common stock.
Preferred Directors - board members hand-picked by the VC. What makes them special is that, in the case of a board vote, even if there is a majority board vote on an action, if a preferred director doesn’t vote for it, then it doesn’t get passed.
Private IPO - raising high volumes of money in the hundreds of millions of dollars (amounts that formerly would have been brought in through an IPO) while remaining private. Sometimes, early investors will sell shares into late-stage “private IPO” rounds. Not technically a “public offering,” but referred to as an IPO because of how much money they bring into a company.
ROI - Return on Investment - the gain or loss generated on an investment versus how much was invested.
Runway - the amount of time until a startup runs out of money (assuming that expenses remain constant). Determined by dividing the current cash position by the burn rate. Ex. if a company’s cash position is $100,000 and it costs $10,000 per month to run the company (that’s the burn rate), then the runway is 10 months.
SaaS - Software as a Service - a software application, hosted centrally, where users are charged a subscription. (See also: PaaS)
Seed Money - money to get a business off the ground. Founders provide the concept and someone else (angel investor, friends and family, etc.--sometimes VCs, too) provides the money.
Series A Funding - a company’s first “grown up” round of funding (even if they’ve raised seed/angel/friends and family, etc.). It gets this name because of the kind of preferred stock that investors get.
Series B (and beyond) - additional rounds of funding that let a company keep raising money to make bigger moves. Of course they’re going to need to be hitting key benchmarks (market penetration, revenue, etc.) to prove that they deserve this extra cash.
Shares Outstanding - these shares are in play; they’ve been authorized, issued, and purchased. They’re out in the world, people own them, and they can make stuff happen. (Contrast with Treasury Stock.)
Shareholder Vote - major company actions are often put to a vote and everyone who has preferred stock gets to vote for or against it. The more shares one has, the more votes they get (holders of common stock don’t get to vote).
Signaling Risk - if a previous investor chooses not to invest in the next round (follow-on), it is a bad signal to other investors because someone with more intimate knowledge of the company than most has opted not to deepen their investment.
Stock Options - stock that is set aside in an employee option pool for employees to purchase.
Term Sheet - the first real piece of paper a founder sees from a VC when they decide that they’re interested in investing. It’s still gonna a pretty complicated document, but its goal is to give both sides of the table a (relatively) short, simple summation of the points that they already agreed on. Here’s a post that contains one company’s Series A term sheet.
Traction - getting somewhere with customers: people are buying a company’s product, subscribing to its service, or otherwise engaging with it.
Treasury Stock - shares authorized and issued by a company that have been purchased by the company itself.
Uncapped Note - basically, the investors get no guarantee of what value the company can be valued at before their note (debt) converts to equity. Ex. with a capped note, a $500,000 investment in a company with a $5M cap would translate to a 10% stake in the company. However, with an uncapped note, the same $500,000 will only translate to a 5% stake in the company if the founders get the company valued at $10M (see capped note).
Unicorn - a private, investor-backed company valued at $1B+. (They have a pretty nifty club.)
Use of Proceeds - sometimes there are limits placed on what companies can use their newly-acquired VC funds for; it behooves founders to keep these terms as vague as possible so that they can do whatever they need to with that moola.
Value-Add Services (or add-on services) - so a VC isn’t just about infusing a company with cash. They also like to help out startups with advice, technology, connections, and more. These non-financial services are also called add-ons.
Valuation - how much a company is worth (or what people think it’s worth).
Venture Capitalist - (VCs) - investors who have collected a fund of money for investments and spread it around to burgeoning companies.
Vesting - the lag period between when someone is awarded a stock option and when they can actually exercise it.
Voting Rights - the ability to vote for or against company actions.
Warrant - a derivative security that lets the holder buy equity at a certain price during a certain window (useful if the stock price goes up).
Waterfall Chart - a chart that shows in what order all private equity investors get paid.
Weighted Average - this is a more moderate antidilution protection approach that uses a formula that takes into account not only the share price of the new issuance, but also the old stock price, number of shares issued, and number of shares overall. It’s more moderate than a full ratchet, which sets the new price without respect to any of these factors.