Coversion rates, vesting, drag-along clause…All the terms you might have heard in a conversation with an investor and kept nodding to not having a clue what they mean. No shame there, we’ve been through it too. Hence, this list of 30 VC terms. We got you.
1. Anti-dilution clause
Contractual safeguard that shields an investor from experiencing a substantial decrease in their investment’s ownership percentage during subsequent rounds of fundraising aka when other investors buy stock in a company. Often applied when shares in a company are sold at a value less than the amount paid originally by existing investors. There are two basic types of anti-dilution clauses:
2. Burn rate
Rate at which the company is spending its capital/cash to cover operating expenses before reaching profitability; calculated on a monthly basis.
3. Capitalization table (cap table)
A document that provides a detailed breakdown of company’s ownership structure, outlining the equity ownership stakes of shareholders, including investors, founders, and employees.
4. Churn rate
Also known as retention rate, the churn rate is a metric that measures the percentage of customers or subscribers who discontinue using a service or product over a given period versus the ones that start.
5. Cliff
Employee stock options typically undergo vesting over a span of several years, meaning they can only be fully converted into stock after this duration. Although vesting schedules follow a linear progression, they commonly include a cliff—a specific period before which no options vest. Similar to vesting in general, the cliff serves to incentivize employees to remain with the company for a longer duration. A typical cliff period is 12 months.
6. Common stock
The fundamental ownership unit in a company, usually held by founders and employees. Early angel investors may also hold common stock. However, institutional external investors, especially VCs, typically demand preferred stock with added rights, notable priority in a liquidation event.
7. Conversion
An irreversible process of converting preferred share to common shares. There are two types of conversion rights: optional and automatic (also known as mandatory).
8. Convertible note
Type of loan that can turn into ownership in a company when there’s another funding round, offering a straightforward way for startups to get early-stage funding. Investors who use convertible notes usually get a share in the company when it raises more money, based on a set formula or discount.
9. Customer acquisition cost (CAC)
Total expense a business spends to acquire a new customer. It is determined by dividing direct acquisition costs by the number of new customers and enables startups to identify the most effective channels in terms of return on investment (ROI).
Once achieving product-market fit, conventional wisdom suggests that your CLTV/CAC ratio should exceed 3:1, and your CAC payback period should be under 12 months.
10. Customer lifetime value (CLTV)
Predicted total revenue business anticipates earning from a customer throughout their entire relationship, reflecting the long-term value and profitability of that customer.
11. Dilution
Reduction of existing shareholders’ ownership percentage in a company when additional shares are issued, typically through fundraising rounds. It’s important to note that if the valuation of the new sale reaches a sufficiently high level, the value of stock held by current investors may rise, despite a potential decrease in their percentage ownership.
12. Down round
Funding round in which a company raises capital at a valuation lower than its previous financing, often resulting in a dilution of existing shareholders.
13. Drag-along right/clause
Provisions in shareholders’ agreement that empower majority shareholders to force minority shareholders to join in the sale of a company, ensuring a unified decision in favour of a potential buyer.
14. Due diligence
Comprehensive investigation and evaluation process conducted by potential investors or acquirers to assess the financial, legal, and operational aspects of a business before making an investment or acquisition decision.
15. Employee Stock Option Pool (ESOP)
Benefit plan that allows employees to become partial owners of the company by receiving shares of its stock, fostering employee engagement and aligning their interests with company performance.
16. Equity
Ownership stake that investors receive in a company in exchange for their investment. It represents their ownership interest and entitles them to a share of the company’s profits, as well as a say in company decisions depending on the type of equity they hold.
17. Flat round
Occurs when startup issues shares at the same post-money valuation as its previous fundraising round. This effectively implies a decrease in the company’s value. Due to dilution, existing shareholders will hold stock worth less than before the round.
18. Fully diluted shares
Total number of outstanding shares company would have if all potentially dilutive securities, such as stock options, restricted stock units, and convertible securities, were converted or exercised. This metric provides a comprehensive view of ownership and is crucial for assessing the company’s valuation and the potential impact on existing shareholders.
19. Liquidation preference
A provision in a contract specifying the order of payment to investors in the event of a company’s liquidation or sale, often prioritizing investors over founders. This clause is frequently employed by venture capitalists to mitigate investment risk, with 1x being the standard multiple.
20. Lock-up period
Predetermined length of time, often imposed on company insiders and early investors, during which they are restricted from selling or trading their shares following an IPO to prevent sudden stock volatility. It often lasts 90 or 180 days, up to a year. 21.
21. Preferred stock
External investors, especially VCs, typically demand preferred stock with enhanced rights compared to common stock, the fundamental ownership unit in a company. These rights prioritize preferred shares in a liquidation event. We distinguish two:
22. Pro rata right
Clause in a term sheet that grants investors the option to maintain their ownership stake by participating in future funding rounds. Investors typically seek pro-rata rights, which is acceptable if founders choose investors for long-term involvement. However, super pro-rata rights, allowing automatic purchase of additional shares beyond dilution, should generally be rejected as they can deter other investors in future rounds.
23. Revenue run rate
Yearly forecast of revenue derived from current revenue figures. It typically reflects the projected revenue for the next 12 months, assuming that the revenue for each subsequent month or quarter remains consistent with the previous one.
24. Right of first refusal (ROFR)
Often granted in VC deals, giving priority to the startup and then the investor in any future stock sale. This provision mandates that existing shareholders must offer their shares to the company and investor before selling to a third party, maintaining the order of priority. Investors may occasionally request a ROFR on future financing rounds, and corporate investors may seek a ROFR on company acquisitions. Founders are advised to avoid both of these provisions.
25. Runway
Financial metric that calculates the amount of time a startup can sustain its operations with the current level of available funds before exhausting its financial resources, often expressed in months.
26. Secondary sale
When an investor purchases shares from an existing shareholder rather than from the company directly through an issuance of stock. Very late-stage companies, usually nearing an IPO, may have large secondary rounds to provide liquidity to existing shareholders. Additionally, starting from Series B or C rounds, a small portion of founders’ and early employees’ shares may be allocated for a secondary sale to offer them liquidity while maintaining their incentives to remain with the company.
27. Term sheet
Non-binding document outlining the key terms and conditions of a potential investment or acquisition, serving as a basis for negotiation between parties involved.
28. Valuation
Process of determining the value of a company when it seeks investment from external sources, such as VCs. It involves assessing various factors, such as the company’s financial performance, growth potential, market position, and industry trends, to arrive at a valuation figure.
29. Vesting
Process in which relevant stakeholders earn ownership rights to stock options or equity grants, gradually, over a specified period of time.
30. Warrant
Similar to stock options, issued to investors. While warrants in equity funding rounds often introduce unnecessary complexity, they play a vital role in bridge loan and venture debt agreements. They help attract lenders or reduce interest rates due to the high default risk associated with lending to startups.