Financing Glossary of Terms
Angel Investors: Individuals who back emerging entrepreneurial ventures, sometimes as a bridge to venture capital. Funding levels typically range from $50,000 to $2 million. Usually successful, sophisticated business people but the term can apply to all individual investors in a company regardless of business experience (see Three F's).
Angel Group: A group of angel investors. An angel group may be an informal meeting of investors in which investors see company presentations collectively but make decisions individually, or it may be a more formal group. At their most formal, angel groups have a paid manager that facilitates the process.
Blue Sky: State regulations governing the sale of securities and mutual funds, designed to safeguard investors from being lured into fraudulent or unscrupulous deals.
Burn Rate: The negative cash flow of a company. It may also be used to refer to the net negative cash flow of a company with consistent revenue. A typically asked question from an interested investor is, "What's your monthly burn?" which really means, "How much do investors have to cover on a monthly basis before you're cash positive?"
Capitalization Table: A statement that describes the stock of a company, including common stock, preferred stock, options, warrants and other equity instruments.
Common Stock: Securities representing equity ownership in a corporation, providing voting rights, and entitling the holder to a share of the company's success through dividends and/or capital appreciation. Prior to an IPO, Common Stock is typically held by founders and reserved for employees through Stock Options; investors will usually use a preferred investment instrument (see also, Preferred Stock).
Cost of Equity Capital/Debt Capital: The cost to the company of an investment or loan, usually in terms of interest requirements but may also include the cost of other features of the investment or debt instrument.
Deal Flow: The flow of deals received by a venture capital company or angel group.
Debt Financing: Financing by selling bonds, bills or notes to individuals or institutions or by borrowing from a bank.
Debt Service The series of payments of interest and principal required on debt over a given period of time.
Deferred Payment: A debt which has been incurred and will be paid back at some point in the future. Can refer to compensation as well as financing.
Dilution: The reduction in earnings per share or ownership percentage that would result from issuing additional stock to raise capital or for an acquisition (see also, Fully Diluted).
Discount Rate: There are two common uses of the term. (1) The interest rate charged by the Federal Reserve for short-term loans to member banks, also called bank rate. The Fed can directly affect business growth by raising or lowering this discount rate. (2) The rate used in discounting future cash flow when making a Net Present Value (NPV) or Discounted Cash Flow (DCF) calculations. The discount rate used in NPV DCF calculations is not usually the same as that of (1) above. It may be the same as, or higher than the company's cost of capital. It is almost never less. It often takes risk into account, and is higher for high risk investments (see also, Hurdle Rate).
Discounted Cash Flow: A method of evaluating an investment by estimating future cash flows and taking into consideration the time value of money.
Due Diligence: Usually undertaken by investors, but also customers, due diligence refers to the process of making sure that someone is what they say they are and can do what they claim (e.g., does the product really work, do they really have customers, etc. ).
Equity: Companies Companies that sell stock or more generally equity to investors to in exchange for investment dollars. Equity is also what entrepreneurs retain as their ownership of the business. An increase in the valuation of a company's equity is an increase in the worth of the company.
Exit Strategy: The method by which a company plans to provide its investors an exit of their investment or, in other words, get their money back plus a return on their investment. Examples are IPO, sale or merger of company, or dividend distributions. The exit strategy, or how the entrepreneur envisions the investor will eventually liquidate his investment, is a critical section of the business plan. Entrepreneurs must demonstrate that they understand and anticipate the investor's exit.
First-Round Financing: The first formal investment in a company made by external investors. Not to be confused with seed financing, which is before first-round investment.
Fully Diluted: A capitalization table shown on a fully diluted basis is such a table shown if all warrants, stock options and convertible securities are taken into account and assumed to be exercised.
Hurdle Rate: The required rate of return in a discounted cash flow Return on Investment (ROI) or Internal Rate of Return (IRR) analysis, above which an investment makes sense and below which it does not. Also called required rate of return.
Internal Rate of Return (IRR): The percentage rate of return that an investor makes on their investment-in other words, if an investor puts into a company X dollars on day 1, and takes out X+ dollars out at some future point(s), what is their percentage rate of return?
IPO An Initial Public Offering is the first offering of securities to the general public by a company that had formerly been a private concern. The ambition of many entrepreneurs and investors because it offers the possibility of the greatest return.
Lead Investor: The investor that is taking a lead position in an investment in a company, usually because they are investing the largest portion of a syndicated investment but sometimes because they are most knowledgeable about a company or have made the first commitment to an investment and are leading the due diligence process. Typically a Lead Investor will have a board seat.
Leverage: The use of debt to increase total capital available to a company. As an example, if you buy something worth $100,000 with $10,000 of your own money and a $90,000 loan, you have leveraged your initial capital.
Leveraged Buyout: Takeover of a company or controlling interest in a company, using a significant amount of borrowed money, usually 70% or more of the total purchase price.
Line of Credit: An arrangement in which a bank or vendor extends a specified amount of credit (secured or unsecured) to a specified borrower for a specified time period.
Mezzanine Financing: In the ideal financing sequence, the Series C round or third round of financing is mezzanine financing prior to some form of exit, either IPO or acquisition.
Milestones: Performance goals against which a company's success is measured. They are sometimes used to determine whether a company will receive additional financing or whether management will receive additional stock. Milestones are sometimes referred to as benchmarks, minimums or performance requirements.
Milestone Payments: Payments by a customer, licensee, or by an investor against the successful completion, by the company, of pre-defined development milestones.
Portfolio: A collection of investments all owned by the same individual or organization. For example, when considering whether to approach a venture capitalist, it is useful to look at their portfolio to determine whether they have synergistic or competitive investments in other companies.
Preemptive Rights: The right of current shareholders to maintain their fractional ownership of a company by buying a proportional number of shares of any future issue of common stock. Most states consider preemptive rights valid only if made explicit in a corporation's charter.
Preferred Stock: Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over Common Stock in the event of a liquidation. Usually does not carry voting rights. However, preferred shareholders may have seats on the board of directors and depending upon the way the corporation is chartered, the board of directors may have substantive authority for company operations and strategy. Preferred stockholders may have conversion rights into Common Stock and may have stock that provides them with accumulated dividends.
Reference Account: A customer account that serves as a point of reference for investors and others in the due diligence process. A reference account is ideally representative of forecasted sales.
Return: Also sometimes the discount rate used in a Net Present Value (NPV) DCF calculation.
SBIR: Small Business Innovation Research Grant, a US government program that provides funding for research. In the right circumstances, the program can provide valuable seed capital for an entrepreneur's new product development activity. The SBIR grants are provided in two phases. Phase I-up to $100K for proof of concept work; Phase II-up to $1 million (except NIH which can sometimes be more) for prototype work and market studies. The SBIR program was created by the Small Business Innovation Development Act of 1982. It requires major government agencies to allocate a portion of their research and development funds to small private businesses through the SBIR program.
Second-Round Financing: The second round of institutional investment (see also, First-round Financing and Series B).
Seed Financing: The first round of financing, often (but not always) by individuals and prior to first-round, which is typically the first institutional round.
Sensitivity Analysis: Investigation into how projected performance varies along with changes in the key assumptions on which the projections are based.
Series A: Preferred stock, which is typically the investment vehicle for first round investors.
Series B: Preferred stock, which is typically the investment vehicle for second round investors.
Stock Option Plan: A trust established by a corporation for the allocation of some of its stock to its employees over time, intended to motivate employees, and often providing tax benefits to the company.
Syndicate: Typically thought of as a group of investment banks which jointly underwrite and distribute a new security offering, for entrepreneurs it usually refers to a group of investors, individuals, institutions or a combination who agree to invest together in a company.
Term Sheet: An outline of the terms of a proposed investment deal, typically set up to be a non-binding precursor to the actual financing agreements that will fully document a funding transaction. Term sheets serve the same purpose as letters of intent and are used frequently by venture capitalists to fix the terms of a deal before they complete their due diligence. While generally unenforceable, term sheets, like letters of intent, often contain binding agreements to prevent management from shopping the deal spelled out in the term sheet., term sheets vary in their level of formality and in the obligations they spell out for the company and the investors. A term sheet is proposed by investors, signed and accepted by the company, and is the precursor to a due diligence effort before the actual investment or plan is made.
Three F's: The joke is that friends, family and fools are often the first money into a company, but this is often true. A fourth f is sometimes added: faculty.
Traunch: Refers to a defined injection of capital into a business. A given financing round (e.g., first round financing) may have multiple traunches. For example, investors may commit a certain total amount to a company, but may invest that commitment over time in multiple traunches based on the meeting of set milestones.
Venture capital: A form of financing for a company in which the business gives up some level of ownership and control of the business in exchange for capital over a limited time frame, usually 3-5 years. The return of the venture capitalist financing is typically through an IPO or an acquisition of the company.
Warrants: An agreement between the company and investors, that gives the holder of the warrant the right to purchase a certain number of shares of stock at a certain price within a certain time frame.