As a startup founder, you are bound to come across several funding terms that might seem confusing at first. Understanding these terms is essential to ensure that you make informed decisions when it comes to securing funding for your startup.
Here are 20 funding startups terms that every founder should know.
Valuation is the process of determining the worth of a startup. It is an important metric that investors use to evaluate the potential of a startup. Valuation can be determined using various methods, including discounted cash flow analysis, market analysis, and comparative analysis.
Equity is the ownership interest that investors have in a startup. When investors provide funding to a startup, they typically receive equity in exchange. The amount of equity that investors receive is determined by the valuation of the startup and the amount of funding provided.
3. Convertible note
A convertible note is a type of debt instrument that can be converted into equity at a later stage. It is a popular option for early-stage startups that are not yet ready to determine a valuation. Convertible notes typically have a maturity date and an interest rate, but instead of paying back the loan, investors have the option to convert it into equity when the startup raises its next round of funding.
Dilution occurs when a startup issues new equity, which decreases the percentage ownership of existing shareholders. It is a natural part of the fundraising process, but it is important for startup founders to be aware of how it can impact the ownership structure of their company.
5. Pre-money and Post-money valuation
Pre-money valuation is the value of a startup before it receives any funding, while post-money valuation is the value of a startup after it has received funding. Understanding the difference between pre-money and post-money valuation is important when negotiating with investors and determining the amount of equity that they will receive.
6. Term sheet
A term sheet is a non-binding agreement that outlines the basic terms and conditions of an investment. It typically includes details such as the amount of funding, the valuation, the percentage of equity offered, and the rights and responsibilities of both the startup and the investor.
Runway is the amount of time that a startup can operate with its current cash reserves. It is an important metric that investors use to evaluate the financial health of a startup and to determine whether to invest.
8. Cap table
A cap table is a spreadsheet that shows the ownership structure of a startup. It lists the names of shareholders, the number of shares they own, and the percentage of equity they hold. Cap tables are important for tracking ownership changes and for determining the dilution of existing shareholders.
9. Liquidation preference
Liquidation preference is a term that defines the order in which investors are paid back in the event of a liquidation event, such as an acquisition or bankruptcy. It determines the priority of payment and can impact the amount of money that investors receive.
Vesting is the process by which equity is granted to employees or founders over a period of time. It is a way to incentivize team members to stay with the company and to align their interests with those of the company.
Anti-dilution is a provision that protects investors from dilution by adjusting their ownership percentage in the event of a down round of funding.
12. Option pool
An option pool is a reserve of shares set aside for future equity grants to employees or advisors. It is important for attracting and retaining talent. Option pool can also impact the ownership structure of a startup.
13. Bridge financing
Bridge financing is a short-term loan or investment that is used to bridge the gap between two rounds of funding. It is typically used to provide working capital and to keep the startup running until it can secure a larger investment.
14. Series A, B, and C funding:
Series A, B, and C funding are different stages of funding that startups go through as they grow. Each round typically involves larger investments from more sophisticated investors and is used to fuel growth and expansion.
15. Lead investor
A lead investor is the main investor in a round of funding. They are responsible for negotiating the terms of the investment and often bring in other investors to participate in the round.
16. Pro rata
Pro rata is a right that allows investors to maintain their ownership percentage in a company when new equity is issued. It gives investors the opportunity to invest additional funds in a company to maintain their proportional ownership.
17. Down round
A down round is a funding round in which a startup raises money at a lower valuation than the previous round. It can be a sign of financial distress or a shift in market conditions.
18. Term loan
A term loan is a type of debt financing that is repaid over a fixed period of time with interest. It is a popular option for startups that need a large amount of capital upfront and can afford to make regular payments over time.
19. Preferred stock
Preferred stock is a type of equity that gives investors certain rights and privileges over common stockholders. It typically has a fixed dividend rate and priority in the event of liquidation.
A warrant is a financial instrument that gives the holder the right to purchase a certain number of shares at a fixed price. It is often used as a sweetener in financing deals to incentivize investors to participate in a round of funding.
Understanding the various funding startups terms is crucial for startup founders who are looking to secure funding for their companies.
From valuation and equity to preferred stock and warrants, there are many terms to be familiar with in the world of startup funding.
By taking the time to learn about these terms and how they impact funding rounds and ownership structures, startup founders can make informed decisions that will help their businesses succeed in the long run.