Startup financing- A few terminologies you need to know

In the last decade, there has been a meteoric rise in the use of the word “Startup”. This is mostly because a lot of successful global brands that are well known were Startups at some point. Just because it is such a buzz word, almost every entrepreneur out there is referring to their business idea as a startup.

However, not every business idea is a startup idea. You can start a small business and scale it over the years to build a big brand as you gain more experience and market share. Startups usually seek to disrupt existing structures/business models and scale up aggressively.

If you are truly running (or intend to run) a Startup, the chances that your business will require funding to scale quickly will be high. Your Startup idea will probably be running (almost) completely on external funds and little revenue for the first years to stand any chance of survival.

The process of Startup financing can be very rigorous and irrespective of your background, the following are a few terms you need to know when in trying to get financing for your startup. If your company is seeking venture capital (VC) investment, it is important that you not only have all the elements of a great pitch, but that the language you use is the same as that of the your potential investors

Accelerator

A type of business incubator that typically accepts startup teams into a three-month program and may provide capital, basic living expenses, office space and mentorship, often in exchange for equity in the startup.

Accounting

The process of contextualizing each transaction to present an accurate picture of the company’s financial performance. Accountants go beyond recording a transaction; they interpret how each transaction impacts the financial status of the business.

Acqui-hire

One company’s acquisition of another for the primary purpose of hiring its employees, rather than for the intrinsic value of the business itself.

Acquisition

An acquisition is when one company or investment group buys another company. Usually over 50% of the equity of the acquired company

Advisor

An individual providing guidance, connections, advice and support to the entrepreneur, often in return for a small equity stake.

Angel group

A formal or informal organization of individual accredited investors who pool their deal flow, resources, expertise and capital to make angel investments.

Angel investor

An individual who invests his or her own money at an early stage in exchange for a share of the company. An angel can be a high net worth entrepreneur or friend or family member willing to invest in a great idea. Angel investors tend to invest fewer dollars than venture capitalists, although some form angel groups to invest in bigger business opportunities.

Angel round

A round of investment into a startup company from angel investors not previously affiliated with the founder. Typically, the first money invested in a company after the founder’s own money and the founder’s friends and family.

Annual recurring revenue (ARR)

The subscription-based revenue which software-as-a-service or platform-as-a-service (SaaS/PaaS)-based companies receive each year; also known as the run rate.

Authorized shares

The maximum number of shares that a company can issue, as decided by its Board of Directors. This must be stated in the incorporation documents of a company

B2B

When one business engages in commercial interactions with other businesses (one business is the supplier and the other businesses are the customers).

B2C

When a business engages in commercial interactions directly with consumers (the consumer is the end-use customer of the product or services provided).

Balance sheet

A condensed financial statement showing the nature and total value of a company’s assets, liabilities, and capital on a given date. Also known as Statement of Financial Position.

Board of Directors

A group of people elected by a company’s shareholders that makes decisions on major company issues, including hiring/firing the CEO.

Bookkeeping

The process of recording all the company’s transactions in a set of books, also known as a ledger. Entries are recorded in accounting software, which will compile reports based on how bookkeepers tag such entries.

Bootstrapping

Funding a company without external help or capital and reinvesting initial profits.

Bridge loan

A temporary investment instrument used to cover a company’s operating expenses until a future financing.

Bubble

A bubble describes a moment in an economic cycle where an industry or company does not realize that it might be overvalued and over-inflated. When a “tech bubble” bursts, it means that a lot of startups go bust and investors lose their money.

Burn rate

The monthly negative cash flow from a startup. The amount of cash a Company is spending each month in relation to Capital.

Business model

A strategic management tool describing a firm’s value proposition, infrastructure, customers and finances.

Business plan competition

A program to encourage entrepreneurs to develop plans for new businesses, and sometimes a showcase competition for existing startups seeking financing.

Buyout

The purchase of a company or a controlling interest of a corporation’s shares, product line or business. A leveraged buyout is an acquisition accomplished with borrowed money or by issuing more stock.

Cap (on a convertible note)

The maximum company valuation at which a convertible note will convert into a company’s stock.

Cap table (capitalization table)

A record of all securities and their shareholders commonly displayed in a fully diluted view.

Cash flow statement

Reconciles the beginning cash balance to the ending cash balance by illustrating the sources and uses of cash from operations, investing, and financing activities.

Cash flow

The amount of money flowing in and out of the business. Free cash flow is the amount left in the business after paying expenditures. Free cash flow is used as a profitability measure of the business.

Certificate of Incorporation

Documents filed with the Corporate Affairs Commission which acts as a charter to document the establishment and existence of a corporation—typically including the business’s name, address, a statement of business purpose, and details related to the types of stock the corporation is entitled to issue.

Churn rate

Also known as attrition rate, churn rate is the percentage of subscribers to a service who discontinue their subscriptions to the service within a given period. For a company to expand its clientele, its growth rate, as measured by the number of new customers must exceed its churn rate.

Cliff

With vesting, a cliff period is used to require stockholders to remain with the startup, usually for at least 1 year, before they can claim a percentage of their shares. Both vesting and cliff periods help stockholders align interests.

Common stock

A form of equity ownership of a company, equivalent to the terms “voting share” or “ordinary share”. In a liquidity event or a bankruptcy, common stockholders receive all the net value of a company after paying the fixed amounts due to bondholders, creditors and preferred stockholders. Common stock usually carries with it the right to vote on certain matters, such as electing the board of directors.

Convertible note

A type of loan (also known as convertible debt) which provides that the amount of money loaned may (or must, under certain conditions) be converted by the investor into shares of stock in the company at a price.

Convertible preferred stock

Preferred stock in a company that is convertible at the option of the holder into common stock at a predetermined valuation. This provides the priority and security of holding preferred stock, as well as the potential value appreciation of common stock.

Crowdfunding

A joint effort by many individuals to support a cause, project or company. Donation-based crowdfunding bears no expectation of returns. In reward-based crowdfunding, contributors are promised rewards (such as the ability to purchase a product) in exchange for their contributions. Equity-based crowdfunding gives funders the ability to purchase equity interests in a company.

Customer Acquisition Cost (CAC)

This refers to the amount needed to pay in marketing and sales expenses to acquire one Customer.

Customer lifetime value (CLTV or LTV)

A forecast of the total net profit related to the entire lifetime of a specific customer relationship.

Deal lead /lead investor

The investor or investment organization taking primary responsibility for organizing an investment round in a company. The deal lead typically finds the company, negotiates the terms of the investment, invests the largest amount and serves as the primary liaison between the company and the other investors.

Debt

Borrowed money that needs to be paid back. The business borrows money for a specific period and promises to pay interest on the money for as long as the loan is outstanding.

Demo day

A public pitch event or “graduation” day for a group of startups in an accelerator or other program for startup companies to present its investment opportunity to potential investors in attendance.

Dilution

When a company sells additional shares of stock, thereby decreasing the percentage ownership of existing shareholders. Note that if the valuation of the new sale is at a high enough level, the value of stock held by existing investors may increase, even though the percentage ownership may decrease.

Discounted convertible note

A loan that converts into the same equity security being purchased in a future investment round, but at a discounted price representing a risk premium for the early investment.

Disruption

Also known as disruptive innovation. An innovation or technology is disruptive when it “disrupts” an existing market by doing things such as: challenging the prices in the market, displacing an old technology, or changing the market audience.

Due diligence

The process of investigation whereby both an investor and an entrepreneur can analyse and assess each other for the potential of an investment opportunity and partnership.

EBITDA

“Earnings Before Interest, Taxes, Depreciation, and Amortization.” By not including interest, taxes, depreciation, and amortization, one can clearly see the company’s operational cash flow.

Ecosystem

As with an ecosystem in nature, a startup ecosystem has its food chain. There are the hunters, the herd and the bottom feeders.  Incubators, accelerators, co-working spaces, mentors, VCs etc all play a part in the ecosystem.

Equity

A corporation is divided into shares, which represent a slice of both the company itself and the value the company creates. These shares, once distributed, represent the company ownership (a word commonly interchanged with equity).

Equity seed round

When an entrepreneur first sells a part of his or her business— and therefore a proportional part of the good things (like profits) and the not-so-good things (like losses)—to an investor. Equity investments, unlike loans, do not need to be paid back.

Exit

When a company is either acquired for cash, sold during a public offering, or abandoned as a failed venture.

Exit strategy

The plan of getting money out of the company by choosing to let go of control. Either to sell it, get acquired (or acqui-hire), merge with another company, go public, or liquidate the business completely.

Fire sale

To sell a company and assets at a heavily discounted price since the founding team is no longer able to maintain/grow the company’s business.

First Mover Advantage (FMA)

A company that leads and innovates to stay ahead of the pack. This is called first mover advantage.

Fully diluted shares

All stock (common and preferred) and issued options (or warrants) as if converted to common stock. This is less relevant in the early days, but it is a representation that investors care about as it most accurately reflects preferences, rights, and decisions made during a liquidity event (e.g. an acquisition or IPO)

Grant

Money provided by a government agency or other organization that does not need to be repaid and does not purchase equity.

Income

Having deducted expenses from revenue, the leftover is the income retained in the business for reinvestment or withdrawal. Income is a better performance metric in measuring the stability and health of the business. On the other hand, high revenue even at losses (negative income) can signal potential.

Incubator

A program or shared office centre designed to support the successful development of companies by offering cost effective resources and support. Startup incubators are groups that support chosen entrepreneurs and/or their businesses with mentorship and funding. In exchange, the incubator takes an equity stake in the company. Increasingly popular and competitive in the tech world, incubators have been touted as the new business schools.

Independent contractor

A specific classification of worker that is not an employee of the company. Usually distinguished by 1) whether the business has a right to direct and control how the worker does the task for which the worker is hired, 2) whether the company has a right to control the business aspects of the worker’s job, and 3) what kind of relationship the worker has to the business.

Initial public offering (IPO)

The first public sale of the stock of a formerly privately held company. After a lockup period, investors are typically able to sell their shares on the public stock market.

Intellectual property (IP)

An intangible asset of value. The protections of IP—trademarks, copyrights and patents—determine if others can copy these creations and restrictions of use.

Investment round

A set of one or more investments made in a company, by one or more investors on essentially similar terms at essentially the same time.

Issued shares

The total number of shares that have been granted by the company and purchased by a shareholder. These are also commonly referred to as issued and outstanding shares.

Launch

A launch is to start a company, website or app. Companies can either have a “soft launch” (minimal press exposure and staying in beta) or celebrate with a “launch party”

Lean Startup

A lean startup is one that has been launched with as little startup capital as possible while getting data that can be used to improve the product. Speed is the key factor here.

Leverage

Leverage is using something to accelerate growth or success. This is often found in the form of technology or partnerships.

Liquidity event

When investors can convert some or all their equity interest in a company into cash. Typically, as the consequence of an acquisition, this can also happen if a company is successful and new investors are willing to buy out the interest of early investors.

Lock up

A period (typically after an IPO or an acquisition of a startup by a public company) during which certain shareholders are not allowed to sell their stock.

Loss Leader Pricing

Loss leader pricing is using deliberately low pricing to gain market share. The key here is to tempt users with the low price or free offer and once acquired, focus on how to get repeat business from them.

Low Hanging Fruit

Low hanging fruits are things that can be identified to quickly bring cash in the door. First customers will keep business afloat and help you get cash cows (reliable and consistent revenue generators) and whales (your accounts that make you big bucks).

Major investor

As used in investment term sheets, any investor who puts in more than a defined amount into a given round and is therefore entitled to specific information and/or voting rights.

Market Penetration

How much market share will be earned and in what period?

Merger

A merger is when two companies join forces and become a joint entity.

Micro-VC

The correct term for organizations often referred to as “super angels.” Structured similarly to a traditional venture fund, a Micro-VC is typically much smaller in size, with fewer partners, and invests less money but at an earlier stage.

Minimum Viable Product (MVP)

A development technique in which a new product or website is developed with sufficient features to satisfy early adopters. The final, complete set of features is only designed and developed after considering feedback from the product’s initial users.

Net Profit

(Also known as bottom line) is the total gross profit minus all business expenses

Non-disclosure agreement (NDA)

A legally binding arrangement between two parties where one or both parties will classify confidential information and prohibit the other party from disclosing shared information.

Options

A different way of distributing ownership-options are the right to buy shares based on a set of conditions. When an option is “exercised,” the option to buy stock is used and the result is issued shares. They are typically used as part of a compensation package in the form of an incentive to employees, directors, advisors, and other people key to the company’s success.

Peer to Peer (P2P) lending

A type of online financing solution through which individuals lend money to other individuals or small businesses.

Patent

An exclusive right, granted by the federal government, conferring the rights to exclude others from making, using, or selling an invention, design, or process for a fixed amount of time.

Pay-to-play

A term in VC financing that requires investors to participate in future down-valuation financing of the company, or else suffer punitive consequences (such as getting their preferred stock converted into common stock).

Pitch

A presentation, typically supported by slides, in which a startup company’s founder describes his or her company and seeks an investment from angels or venture capitalists.

Pivoting

When the initial business model is not working, the CEO and team often pivot to a plan B. The initial mission might stay the same, but what changes is the plan on how to get there.

Portfolio

A collection of companies invested in by an angel or VC.

Post-money valuation

The value of a company immediately after it has received an equity investment, including both the company’s pre-money valuation and the amount it received from the investment.

Preferred stock

A type of equity ownership of a company that has both a fixed value and priority in liquidation sequence.

Pre-money valuation

The value of a company immediately prior to receiving an investment, used to determine what percentage of a company’s ownership will be purchased in exchange for a specified investment amount.

Private companies

Companies that are not publicly traded on the stock market.

Proof of Concept (PoC)

A complete cycle that proves a business idea can work for at least one customer.

Public companies

Companies that are freely traded on the public stock exchanges such as the Nigerian Stock Exchange.

Return on investment

The amount of money or net benefit generated by an investment or spend.  It is the money an investor gets back as a percentage of the money he or she has invested in a venture

Runway

How long a startup can survive before it goes broke; that is, the amount of cash in the bank divided by the burn rate.

Seed fund

A venture capital fund specializing in very early-stage startups.

Seed round

When a few investors provide capital to a new company. Investors are typically rewarded with convertible notes, equity, or a preferred stock option in exchange for their investment.

Series A

When a few angel investors or VCs contribute in exchange for equity. The fund is named after the type of equity investors hope to receive: Series A preferred shares. This implies they will be the first group of investors to receive preferred shares.

Series B, C, D…

Investment rounds from venture capital funds after the first Series A round.

Shareholders’ Agreement

An agreement signed during a financing transaction by all a company’s shareholders in which they agree in advance to various provisions. These will typically include indicating which parties are entitled to designate members of the board of directors and thus control the company.

Soft landing

A face-saving acquisition of an unsuccessful startup, usually for little or no compensation.

Strategic investor

A corporate investor funding an early-stage company primarily for reasons related to the investing company’s interest.

Success fee

A percentage commission paid to an intermediary or other individual as an incentive on the closing of a large financing transaction.

Sweat equity

The equity or ownership interest created in a startup by its founders because of their contributions in the form of hard work and toil. Sweat equity is when you give shares of your company to early employees or contractors in place of cash. This is quite common in the startup world before funding arrives. If you take a chance with a startup, your shares might become lucrative when the company sells.

Term sheet

A summary of the major terms of an investment round that is agreed upon by all parties prior to beginning extensive legal documentation for the round.

Trademark

Grants a business the exclusive right to use the mark, words, symbols, or title in commerce.

Value proposition

A statement a company uses to express why customers should purchase their product or service, including the ways it adds more value than that of alternative offerings.

Venture capital fund

An investment fund that puts money behind high-growth companies.

Venture capitalist (VC)

A professional who invests money in businesses in exchange for an equity share of the company. Because VCs and venture capital firms invest for investors, funds, pension plans, etc. they usually focus on proven or later-stage startups and invest greater amounts of money.

Vesting

A concept applicable to both stock and options, which prevents the recipient from owning all stock or options outright and instead earn them over time. For stock, vesting typically refers to stock that is earned over time and, therefore, not re-purchasable by the company. For options, vesting indicates the number of options that become exercisable.

Vulture capitalist

A VC whose operating method is to deliberately take advantage of an entrepreneur’s troubles.

Waterfall

The order in which investors (and everyone else) get their money out on an exit. Almost always this is “last in, first out.”

Working Capital

The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.

The list above is not exhaustive and with each passing day, the ecosystem evolves with new terminologies and patterns. However, if you have an idea of the basic lingo, it will go a long way in understanding how investors think and what they are looking for to help gain funding.

Finally, it is one thing to know the lingo and it is another to know how to apply them. It is recommended to hire a professional that can help your startup maximize its potential to the highest levels of funding. Talk to us at myCFOng today.