Glossary of VC terms

Accelerated vesting — a speeding up of the vesting schedule, for example in case of an exit.

Angel — a wealthy individual who invests in companies in relatively early stages of development.

Anti-dilution protection — a clause that protects an investor from a reduction in the value of his shares due to the issuance by the company of additional shares to other entities at a per share price that is lower than the per share price paid by the investor. The protection consists of an adjustment mechanism called a Ratchet.

Bridge loan — a short-term loan that will eventually be replaced by permanent capital from equity investors or debt lenders. In venture capital, a bridge loan is usually a short-term note (six to twelve months) that converts to preferred stock.

Broad-based weighted average — a system used in connection with anti-dilution protection. A broad-based weighted average protection adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to a new investor B at a price lower than the price investor A originally paid. Investor A’s preferred stock is re-priced to a weighted average of investor A’s price and investor B’s price. If a broad-based weighted average systemis used, the denominator of the formula for determining the new weighted average price contains the total number of outstanding common shares (on an as-if converted basis) on a fully diluted basis (including all convertible securities, warrants and options).

Burn rate — the rate at which a company uses up its available funds (normally in order to meet its growth targets and cover its expenses). The burn rate is usually expressed on a monthly or weekly basis.

Business plan — a document that describes a business opportunity and the manner in which such an opportunity can be transformed into a successful business. A business plan typically includes the following chapters: executive summary, product, management team, marketing plan, business system and organisation, realisation schedule, risks and financing.

Capitalisation table — a table providing an overview of the company’s equity securities and, if any such securities have been issued, non-equity securities that can be converted into equity securities. The capitalisation (or cap) table usually also provides an overview of the owners of the aforementioned securities.

Capital gains — investment earnings resulting from the purchase and sale of shares or other assets.

Conversion — the converting of an investor’s preferred shares into common shares at a pre-set conversion ratio; or the conversion of convertible notes into preferred shares at a conversion ratio based on the issue price of a future financing round.

Convertible note — a loan that allows the lender to exchange the debt for preferred shares in a company at a conversion ratio based on the issue price of a future financing round.

Convertible preferred shares — a type of shares that give the owner the right to convert such preferred shares to common shares. Convertible preferred shares are the most common type of equity used by venture capital investors to invest in companies.

Co-sale right — a right that enables an investor to include his shares in any sale by another shareholder at the same price and under the same terms and conditions that apply to the other shareholder. Also referred to as a Tag-along right.

Covenant — a legal promise to do or not do a certain thing.

Crowdfunding — the practice of funding a company by raising many small amounts of money from a large number of individuals, usually via the internet, based on a donation, rewards, lending or equity model.

Cumulative dividends — dividends that accrue. If a company cannot pay a cumulative dividend when it is due, it is still responsible for paying it in the future. The company must fulfil this obligation before it can pay out dividends to holders of any other classes of stock.

Default — a company’s failure to comply with the terms and conditions of a financing arrangement.

Demand registration — a type of registration right. Demand registration rights give an investor the right to force a company to register its shares with the SEC. A demand registration right gives an investor control over the timing of a registration and in effect means that the investor can force the company to go public.

Dilution — see Economic dilution, Price-based dilution and Dilution of ownership.

Dilution of ownership — the reduction in the ownership percentage of current investors, founders and employees caused by the issuance of new shares to new investors.

Dividends — a share of profits paid by a company to its shareholders. Dividends can be paid in cash or in shares.

Down round — a financing round in which the valuation of the company is lower than the value determined by investors in an earlier round.

Drag-along rights — a right that enables a shareholder to force the other shareholders to sell their shares of the company.

Due diligence — an investigation of a company aimed at assessing the viability of a potential investment and the accuracy of the information provided by the company. This investigation usually focuses on the legal, financial, tax and commercial position of the company.

Dynamic equity split — the concept that everyone involved in the early- stage phase of a start-up receives rewards (that can be converted into equity) for their contribution, based on an agreed calculation method.

Early stage — the early phase of a company’s life. This term is used to indicate the phase after the seed (formation) stage but before the phase in which the company starts generating revenues.

Employee Stock Option Plan (ESOP) or (Restricted) Stock Ownership Plan — a plan established by a company to let certain employees benefit strongly from the increase in value of the company. Under an ESOP, certain employees have a right to buy shares in the company at a predetermined price (exercise price) within a specified period of time (exercise period). Under a (Restricted) Stock Ownership Plan, employees are not granted options, but buy shares at once. ESOPs and (Restricted) Stock Ownership Plans offer companies a way to employ (and retain) high-quality people at relatively low salaries.

Equity — Equity represents ownership in a company and is usually represented by common shares and preferred shares. Equity is equal to assets less liabilities.

ESOP — see Employee Stock Option Plan.

Founder — a person who participates in the creation of a company.

Full ratchet protection — a type of anti-dilution protection. If new preferred shares are issued to investor B at a (per share) price that is lower than the price investor A paid in an earlier round, the effect of the full ratchet is that the per share price of investor A is adjusted downward to the price paid by investor B. Usually, as a result of the implementation of a full ratchet, the company management and employees who own common shares suffer significant dilution.

Fully diluted basis — a methodology for calculating per share ratios. Under this methodology, the denominator is equal to the total number of shares issued by the company, whereby it is assumed that all common share equivalents (such as convertible notes, convertible preferred shares, options, warrants, etc.) have been converted into common shares.

Initial public offering (IPO) — a company’s first sale of shares to the public also referred to as going public. An IPO is one of the ways in which a company can raise additional capital for further growth.

Internal rate of return (IRR) — the interest rate at which a certain amount of capital today would have to be invested in order to grow to a specific value at a specific time in the future.

IPO — see Initial public offering.

IRR — see Internal Rate of Return.

Issuer — the company issuing securities.

Later stage — the later phase of a company’s life. In this phase, the company has proven its concept, achieved significant revenues, and is approaching cash flow break-even or positive net income. A later stage company is typically about six to twelve months away from a liquidity event such as an IPO or strategic take-over.

Lead investor — The firm or individual that organises a round of financing and usually contributes the largest amount of capital to the deal.

Liquidation — The selling of all the assets of a company and the use of the cash proceeds of the sale to pay off creditors prior to the complete cessation of operations.

Liquidation preference — the right of an investor to priority in receiving the proceeds from the sale or liquidation of a company. This right is usually attached to the preferred shares and gives the holders of such shares a position that is senior or ahead of the holders of common shares or junior preferred shares if the company is sold or liquidated.

Liquidity event — an event that allows an investor to realise a gain or loss on his investment. Examples of liquidity events include Initial Public Offerings (IPOs), trade sales, buy-outs and take-overs.

Lock-up agreement — an agreement not to sell or transfer shares in a company for a specific period. Underwriters, for example, require lock-up agreements in most IPOs. In such cases, they will usually require the largest shareholders and directors of the company to agree to a lock-up period of six months following the IPO.

Narrow-based weighted average anti-dilution — a system used in connection with anti-dilution protection. A narrow-based weighted average protection adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to a new investor B at a price lower than the price investor A originally paid. Investor A’s preferred shares are re-priced to a weighted average of investor A’s price and investor B’s price. If a narrow-based weighted average system is used, the denominator of the formula for determining the new weighted average price contains only a total number of outstanding shares (as opposed to the number shares on a fully diluted basis). This number can vary from all pre-money outstanding shares (on a non-converted and non-diluted basis) to only the preferred shares issued in the previous round. The narrower the base, the larger the effect of the new price and the more favourable the clause is to the protected investors.

Non-compete — an agreement often signed by key employees and other persons (such as management) who are key to the success of a company pursuant to which such persons agree not to work for competitor companies or form a new competitor company within a certain time period after termination of their employment with the company.

Non-cumulative dividends — dividends that do not cumulate. In other words, if the cash flow of the company is insufficient to make payment of dividend possible at a certain point in time, the owners of the shares entitled to non-cumulative dividends will not receive the dividend owed for the time period in question (also not at a later stage) and will have to wait until another set of dividends is declared.

Non-solicitation — an agreement often signed by employees and management that prohibits such persons, once they have left the company, from soliciting the customers and employees of the company.

Non-disclosure agreement — an agreement often signed by key employees and management that is aimed at protecting the company against improper disclosure or use of the company-sensitive information and materials that are not known to the general public.

Pay-to-play — a clause that is aimed at punishing investors who do not participate on a pro rata basis in a financing round, by cancelling some or all of their preferential rights. The most onerous version of pay-to-play is automatic conversion to common shares, which in essence ends any preferential rights of an investor, such as the right to influence important management decisions.

Pari passu — a legal term that means in equal proportion. It usually refers to the equal treatment of two or more parties in an agreement.

Participating dividends — the right of holders of certain preferred shares to receive their preferred dividends and share (with the common shareholders) in the dividends available for distribution after the preferred dividend has been paid.

Participating preferred share — a preferred share that is entitled to participating dividends. A participating preferred share can in effect be split into two parts: a preferred share part and common share part. The preferred share part entitles the owner to receive a predetermined cash dividend. The common share part represents additional continued ownership in the company.

Piggyback right — the right of an investor to follow in the process to have shares registered. In the case of piggyback rights, this process is initiated and controlled by others. Consequently, the investor cannot force the company to go public.

Post-money valuation — the valuation of a company immediately after an investment in the company. If, for example, an investor invests €2 million in a company valued at €1 million pre-money (before the investment was made), the post-money valuation will be €3 million.

Preference — a preferred position, or seniority. In venture capital transactions investors usually have preference with respect to dividends and proceeds from a liquidity event, for example.

Preferred share — a type of share to which certain special rights are attached that are not attached to common shares. These special rights may include preferred dividends, anti-dilution protection, voting rights, drag-along rights, tag-along rights, liquidity preference, rights of first refusal, etc. A venture capital investor will normally only subscribe to preferred shares.

Pre-money valuation — the valuation of a company immediately before an investment in the company.

Private equity — equity investments in non-public companies.

Private placement — the sale of securities directly to a limited number of investors.

Prospectus — a formal written offer to sell securities that sets forth a plan for a (proposed) business opportunity and that gives sufficient detail about such opportunity for a prospective investor to make a decision.

Qualified IPO (or Qualified Offering) — a public offering of securities that meets certain predetermined criteria, such as a minimum per share price and minimum proceeds to the company.

Redemption rights — the right of an investor to force the company to repurchase the investors’ preferred shares.

Registration — the process whereby shares of a company are registered with the relevant authorities in preparation for a sale of the shares to the public.

Registration rights — the rights of an investor in a company regarding the registration of the company’s shares for sale to the public. Examples of registration rights are piggyback rights and demand rights.

Right of first refusal — a right to match any offer made for shares held by a shareholder, under the same terms and conditions, and thus to pre-empt any other buyers.

Round — an event whereby financing is provided to a company by one or more investors.

Security — a document that indicates that the holder owns a portion of a company’s equity or debt, or has the right to purchase or sell such portion. Shares, notes, bonds and options are examples of securities.

Seed round — the first financing round after incorporation of the Company. Funds are provided by seed venture capitalists, angels (high-net-worth individuals) or friends and family to the founders of a start-up company. The amount raised with a seed round usually does not exceed 2 million euros.

Seniority — higher priority.

Series A preferred shares — preferred shares issued by a company in exchange for capital from investors in the Series A round of financing.

Series A round — the first significant financing round in which one or more venture capitalist(s) become(s) involved in a fast-growing company that was previously financed by founders, seed venture capitalists and/or angels. Usually, a Series A round raises from two to ten million euros.

Series B round — the financing round following the Series A round in which additional funds are provided to the company. Subsequent rounds are called C, D, and so on.

Stock — a share of ownership in a company.

Stock Appreciation Rights (SARs) — rights, usually granted to employees, to receive a bonus equal to the appreciation in the company’s shares over a specified period.

Stock option — a right to purchase or sell a share at a specific price within a specific period.

Subordinated debt — a loan over which a senior loan takes priority. In the event of a liquidation of the company, subordinated debt-holders receive payment only after senior debt is paid in full. Also known as junior debt.

Syndicate — a group of investors that agree to provide capital to a company under the same terms. The term syndicate can also refer to a group of (investment) banks that agree to participate in, for example, the sale of stock to the public as part of an IPO.

Tag-along right — the right of an investor to include his shares in any sale by another shareholder at the same price and under the same terms and conditions which apply to such other shareholder. Also referred to as Co-sale right.

Term sheet — a document summarising the basic terms and conditions under which investors are prepared to make a potential investment in a company.

Underwriter — an investment bank that commits to the successful distribution of a public issue, failing which the bank would take the securities being offered into its own books.

Value inflection point — an event or series of events that results in a significant change in the value of a company. An inflection point can be considered a turning point after which a dramatic change, with either positive or negative results, is expected to result.

Venture capital — a segment of the private equity industry, which focuses on investing in new companies with a high growth-rate.

Voluntary conversion — the right of an investor to convert his preferred shares into common shares.

Voting right — the right of a shareholder to vote on certain matters affecting the company.

Warrant — a right to buy a specified number of shares at a fixed exercise price by exercising such right prior to a specified expiration date. A warrant is a long-term option, usually valid for several years or indefinitely.

Weighted average protection — a type of anti-dilution protection. If new preferred shares are issued to investor B at a (per share) price which is lower than the price investor A paid in an earlier round, the effect of the weighted average protection is that the per share price of investor A is adjusted downward to a weighted average of the price paid by investor A and the price paid by investor B. For the new price the weighting factor is the number of shares issued in the dilutive financing round. For the old price, the factor is either (i) the total number of common shares outstanding prior to the dilutive financing round on an as-if converted and fully diluted basis (broad based weighted average) or (ii) any number of shares outstanding prior to the dilutive financing round less than the number under (i) (narrow based weighted average).

Zone of misalignment — the range of exit values were the interests of the holders of common shares and preferred shares are misaligned due to the effects of the liquidation preference.

Glossary of VC terms: Text