Startup Jargon every founder should know when raising capital.
A Long Long time ago in a city far far away.. Well, Milton Keynes to be exact and is only about 28miles from where I live. I worked for a company called Mahindra BT, or now known as Tech Mahindra. My end client was BT Exact and I remember after a week at BT that I needed some sort of translator for all the BT acronyms. I mean seriously it was ridiculous and you could look like a prize muppet for not understanding 50% of a conversation.
The investment world is similar in some ways and I watch people’s faces when I am chatting away and can see they are being polite but want to ask what I just meant by some terms.
So here is what I hope is a useful Jargon, Lingo, translator for startup investment terms.
Term Sheet - Firstly, please remember, these things are nonbinding. It’s an agreement that sets out the terms of the deal between parties. You pretty much negotiate this document and it acts as a summary into further documents such as Articles of Association and Shareholder agreements. There is a smart way to negotiate these documents and another way that burns time and kills deals.
Pre Emption Rights - Pretty much every shareholder in UK early-stage companies get these rights. When companies raise money, existing shareholders get diluted. These rights mean that a shareholder gets 1st call on buying further shares to keep their position. It’s done before you go to the open market.
Investor consent - So if you are doing a Business Angel or VC round, then expect this to be the norm. Early-stage companies have founders who have a majority stake. However, I have just put my hard-earned cash in and the founder might turn out to be a not so good CEO and make some dumb decisions. This is where Investor Consent comes in and usually includes decisions about salaries, debt being taken on, etc.
Board Positions - I will do a separate article on this as it can be a minefield and in the last 14months I have seen more and more investors demand a board position or the annoying board observer role. Companies at such early stages end up with these massive boards and it’s a minefield to get right and sometimes say no.
Board Approval - So this is a second level to Investor Consent. Reason is that in many situations Investor Consent can veto the board decision. Boards are there to keep the right governance and do the right thing by the shareholder. So day to day, the CEO runs the company, but the board will need to provide approval on this.
Liquidation preferences - You might also hear this referred to as a ratchet. So let me explain two things about this that are key. Liquidation preference refers to when a sale happens. VC’s typically want their money out before other shareholders at a guaranteed value. The same is for a winding up order on the business. But be warned, that it takes some time to get preferences to not be part of any raise, so agree with caution. Also the preferences may give a guaranteed return to those investors of x3 but leave little money for family and friends, other shareholders.
Useful link below on raising Seed Investment
Warranty liability cap - So let's explain what warranties are. Most founders are up front about everything about their business. However, some are not and especially at Seed level, things in a DD slip through the net, that come out after the cash has hit the bank.
A liability cap is set usually per founder and is a personal amount of money they are liable for if things are not as they said they were.
Warranty liability floor - So this is the opposite to the cap. If shareholders wanted to raise an issue against the company for £10k, and your floor amount was £15k then no one would take action.
Hockey Stick - The shape of a growth curve VC’s(for the most part) want to see. So double your sales yearly. Don’t try to do x4 over a year.
Market Penetration - The percentage of a total market that your startup will win as customers, within a given timeframe.
Runway - To what time period will any money you raise last. Be specific as the next question you might get is, what if things don't go to plan, how is that time period affected and when will you need to start raising.
ARR/MRR - Annual recurring revenue is predictable income that a business receives each year. Annualised version of MRR.
Burn Rate - Rate at which a company spends cash reserves to cover expenses, expressed monthly or weekly. Usually applied to a company with little or no revenues.
Convertible Note - A convertible note is short-term debt that converts into equity. In the context of a seed financing, the debt typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. In other words, investors loan money to a startup as its first round of funding; and then rather than get their money back with interest, the investors receive shares of preferred stock as part of the startup’s initial preferred stock financing, based on the terms of the note.
Customer Acquisition Cost - An important metric in unit economics, the CAC allows a company to keep track of how much it costs to acquire a new customer. Calculated as direct acquisition costs (generally marketing and sales expenses) divided by the number of new customers, the CAC allows a startup to understand which channels deliver the best ROI for marketing spend.
Data Room - A data room (also known as a virtual data room) is an online repository of information that is used for the storing and distribution of documents. Generally used to house documents relating to due diligence in funding rounds.
Unit Economics - Important when calculating the profitability of a product or service. Loosely calculated as Lifetime Value (LTV) of a customer divided by Customer Acquisition Costs (CAC).