22 Key Terms Every Startup Should Know.
Navigating the world of venture capital (VC) can feel like learning a new language. Whether you’re a startup founder seeking funding or simply curious about the VC space, understanding the key terms is essential to making informed decisions. Below is a glossary of 22 fundamental venture capital terms that startups should know when discussing investment rounds, equity, and funding agreements.
1. Tag-Along Rights
Tag-along rights give minority shareholders the right to sell their shares when majority shareholders sell theirs. This ensures that minority shareholders can benefit from the same terms as the majority and aren’t left behind in a transaction.
2. Drag-Along Rights
Drag-along rights allow majority shareholders to compel minority shareholders to join in the sale of the company, under the same terms and conditions. This ensures that a potential buyer can acquire 100% of the company without being blocked by minority shareholders.
3. Vesting
Vesting is the process by which an employee or founder earns their equity over time, usually based on a schedule. For example, after one year (the cliff), a percentage of shares may vest, with additional shares vesting over the next few years.
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4. Minimum Viable Product (MVP)
An MVP is the most basic version of a product that includes only essential features. It is used to test the market and validate the product idea before committing further resources to development.
5. Buyback
A buyback occurs when a company repurchases its own shares from investors or the open market. Startups may use buybacks to consolidate ownership, reduce dilution, or prepare for an IPO.
6. Right of First Refusal (ROFR)
The right of first refusal gives existing investors the option to purchase shares before they are offered to a third party. This helps investors maintain their ownership percentage and influence in the company.
7. Anti-Dilution
Anti-dilution provisions protect investors from losing ownership percentage during subsequent funding rounds, especially in a down round. These clauses can adjust the conversion price of preferred stock to ensure investors maintain their equity stake.
8. Employee Stock Ownership Plan (ESOP)
An ESOP is a program that gives employees the option to buy company shares as part of their compensation. This aligns employees’ interests with the company’s success and is often used as a retention tool in startups.
9. Down Round
A down round occurs when a company raises funds at a valuation lower than in previous funding rounds. This can dilute the value of shares for existing investors, but it’s sometimes necessary for securing further investment in tough times.
10. Convertible Note
A convertible note, used in early-stage financing, is a loan that converts into equity during a later funding round, often with a discount or cap on the conversion price. This allows early investors to get more favorable terms compared to later investors.
11. Cliff
A cliff is a specific period, usually one year, before any stock options or equity granted to an employee or founder become vested. If the person leaves the company before the cliff period ends, they forfeit their equity.
12. Cap Table (Capitalization Table)
A cap table is a detailed breakdown of a company’s ownership, showing how much equity each shareholder owns. It’s an important tool used to track the distribution of shares among founders, employees, and investors, especially as new rounds of funding occur.
13. Burn Rate
Burn rate refers to how quickly a company is spending its cash reserves, usually expressed as a monthly figure. Startups monitor their burn rate closely to ensure they don’t run out of cash before the next funding round or becoming cash-flow positive.
14. Seed Capital
Seed capital is the initial funding used to start a business. This money is often provided by angel investors, friends, or family and is typically used to develop a minimum viable product (MVP) or conduct early market research.
15. Convertible Note
A convertible note is a type of short-term debt that converts into equity during a future financing round. It’s often used during seed funding when it’s difficult to determine a company’s valuation. The note may come with a discount or valuation cap for early investors.
16. Exit Strategy
An exit strategy is a plan for how investors will realize their returns, typically through an acquisition, merger, or IPO. For founders, it’s essential to align exit strategies with investors early on in the relationship.
17. Initial Public Offering (IPO)
An Initial Public Offering is when a private company offers its stock to the public for the first time. This is a major milestone for startups and often provides investors with a way to “exit” and realize returns on their investment.
18. Series A, B, C Funding
Series A, B, and C are stages of venture capital investment. Each “series” represents a new round of funding:
- Series A: Early-stage funding to scale a business model.
- Series B: Expansion funding to increase product or market reach.
- Series C: Late-stage funding for significant scaling or acquisitions.
19. Valuation
Valuation is the process of determining the current worth of a company. For startups, this is a critical factor in negotiations with investors, as it dictates how much equity they will need to give up in exchange for investment.
20. Equity
Equity refers to ownership interest in a company, typically in the form of stocks or shares. When investors provide funding, they often receive equity in return, which gives them a stake in the company’s future success.
21. Term Sheet
A term sheet is a non-binding agreement that outlines the basic terms and conditions under which an investment will be made. It serves as the foundation for the final contract and includes key details such as valuation, amount of investment, and investor rights.
22. Angel Investor
An angel investor is an individual who provides capital to early-stage startups, often in exchange for equity or convertible debt. Angel investors typically come in during the “seed” stage and play a critical role in helping startups get off the ground before larger venture capital firms get involved.
Conclusion
Understanding these key venture capital terms will help you navigate the complex world of startup funding. Whether you’re negotiating your first term sheet or preparing for an IPO, having a solid grasp of these concepts will give you a strategic advantage in discussions with investors and stakeholders.
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