|Like many professions, venture capitalists speak their own language. It’s easy to get lost in the lingo — quick test: what are your thoughts on loans that automatically convert into equity upon the closing of a Series A? — but it’s not too hard to learn some basic concepts. More than that, you need to learn; here, from CEO and co-founder of Retention Science, Jerry Jao, if you’re trying to raise money. This is not a comprehensive list, nor is it designed to be. Instead, it is to offer a few common terms you’ll hear in the world of venture capital.
- Basic Venture Capital Terminology
- Let’s begin with a few basics. A portfolio company is one that a venture capital firm has invested in (and thus, is a part of their portfolio of companies).
- Before that happens, an investor performs due diligence, or a thorough, detailed analysis of the company.
- As an example, one of the considerations would be the return on investment, or ROI. Quite simply, this is the money the investor would get back from their initial investment.
- After investigating the company, if a firm decides to invest, a term sheet will be issued. This is a non-binding document that details the terms and conditions of the investment. It’s sort of like the quick introduction to the investment opportunity, highlighting some of the more complex legal documents that will follow.
- Angel Investor: An individual (as opposed to a firm) who provides early capital to a young company. This often happens—as you will read more about below—in the form of convertible debt or equity ownership. It’s common for groups of angel investors to form, which allows them to pool their resources and be more diverse in the guidance they have to offer the companies they choose to invest in.
- Pre-money and post-money valuation: One of the more challenging tasks of a younger company is to assess its actual value—how much it’s worth. Though not impossible, it’s not always a simple task. With that in mind, pre-money valuation simply refers to what your company is worth before it receives any sort of funding. Let’s say the agreed upon valuation is $3 million. If a venture capital firm then invests another $1 million, the post-money valuation would of your company would be $4 million (or, the sum of the pre-money valuation, and the additional funding).
- Convertible Debt: When a company’s valuation is harder to determine—particularly at earlier stages, which tend to be riskier for investors—a company can still raise money. Convertible debt is rather simple: the company receives a loan, and promises that the debt it accrues will then be converted into equity at a later date—when the company is financed in the future. It’s a concept that is both loved and abhorred, but it does allow a means for a young company to secure investment, and it prevents the investor from being diluted in later rounds.
- Other Methods of Financing: Convertible debt sits somewhere between debt and equity financing, but these two are worth discussing with a bit more detail.
- Debt financing happens most often when a company sells a note to an investor, promising to repay the debt with interest.
- Equity financing happens when a company raises money by selling its shares for cash. Shareholders then become partial owners of the company, facing both the risk and the reward that may follow. It’s worth noting that debt and equity financing can happen independently or in conjunction with each other.
- Rounds of Financing: Startups raise money from venture capital firms in different rounds. The seed round is the first official round and it happens relatively early on. At this point, the startup is looking for money to prove their concept, and that money can be helpful in building a prototype of their product. Depending on a variety of metrics that measure a company’s growth and development—for example, how they are acquiring and retaining customers, their revenue streams, and the amount of money they spend each month—the seed round may be followed by others. These are called Series A, B, and C. A company may also seek a bridge loan, which is designed to “bridge the gap” between rounds.
- Incubator: Something of a newer concept, incubators are entities that advise and develop young companies in their earlier days, most commonly before they have received significant investment. Aside from offering the companies physical workspace, they provide an array of services—marketing help, guidance on product development, legal assistance, access to a network of investors, and pitch/presentation training—designed to ready them for growth and success.
- Exit Strategy: Throughout the life span of a company, and as it continues to grow, it’s common to hear chatter about what its exit strategy might look like. This is the way an investor will see the return on his investment. It most commonly happens through an Initial Public Offering (IPO), or a buyout. An IPO marks the first moment that shares of stock are offered to the public. When this happens, it becomes publically traded, and is subject to an entirely new array of securities regulations (among other things). A buyout is when a purchaser gets controlling interest in a company after it buys the requisite number of shares.
Of course, there are plenty more, but these are a good start. Don’t let confusing jargon intimidate you. Take some time getting fluent in these (and other) terms, and you’ll reap the benefits.