Prep

Funding 101: Prep

 

Common Venture Investment Terms

Digging into the world of venture investment can be mind-numbingly painful with all of the lingo and jargon that surrounds these deals.

There are two categories of terms to worry about - those that you'll understand easily by reading below and those that you'll probably need an attorney to explain. Needless to say, we are going to cover the former here.

Most investors are going to expect you to be fluent in at least the common venture investment terms below.

Valuation

When you hear about companies raising money on a "big valuation" they are referring to the projected value of the company that was agreed upon when the investment was made. Note we're saying "projected value" because most valuation amounts are highly speculative (read: “made up”) in the venture investment world.

You'll commonly hear two methods for expressing the valuation of a company:

Pre-Money Valuation - The amount the company is valued at before money is invested. If you valued your company at $5 million, the Pre-Money Valuation would be $5 million, as in "before money was invested."

Post-Money Valuation - The amount the company is valued at after the money is invested. If your company was valued at $5 million before the investment, and the venture investment was $1 million thereafter, the Post-Money Valuation would be $6 million.

Dilution

The effect of giving someone else part of the company's stock is considered "dilution". It means that you are diluting your equity stake to make room for someone else. When you're worried about "giving away the company" that's called dilution.

Cap Table

It's short for the "Capitalization Table" and means a detailed list of exactly how much stock each entity or person owns. Think of it like a spreadsheet that simply lists names and percentage ownership stakes all adding up to 100%.

Common and Preferred Stock

There are many "classes" of stock that can be issued in a company. Each class may have its own rights and preferences. Investors typically get Preferred Stock which may give them preferences such as the ability to get their investment back first before the rest of the Common Stock holders get their proceeds. Founders and Employees are usually left with Common Stock which typically means you're the last person to get paid.

Vesting

Vesting is a process by which you "earn" your stock over time, much like you earn your salary. The purpose of vesting is to grant stock to people over a fixed period of time so they have an incentive to stick around. A typical vesting period for an employee or Founder might be 3 - 4 years, which would mean they would earn 25% of their stock each year over a 4 year period. If they leave early, the unvested portion returns back to the company.

Stock Option Pool

When a company takes on an investment, the investor will usually request (read: insist, strong arm, force, drop kick) that you allocate a certain percentage of the company's shares to a Stock Option Pool for future employees. This sounds all well and good, but it comes out of your portion of the stock, not the investors. Stock Option Pools will range from as little as 5 points of equity to as much as 20 points.

The Least You Need to Know

Chances are you’re only going to get presented with the terms we’ve described in early meetings. Most of the complicated stuff won’t appear until you’ve been presented with a term sheet that involves more complex terminology. Don’t worry – that’s what a good attorney can help you sort through. For the time being just be ready with a few key terms and you’ll be just fine.