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Raising Capital? Terms Every Entrepreneur (and Investor) Should Know

Let’s do this 2021! At the beginning of the year, you may be considering starting a new business or doubling down on one you started in 2020 or years prior. If you are going to grow your venture and are thinking of raising capital to fund the next stage of growth for your company, there are many things you need to know about your business and the process of investing. 

Here are a few basic terms every entrepreneur and investor should know before starting fundraising (or investing): 

Seed Capital (Stage):

Just like it sounds, seed capital is the initial capital that funds a business. Seed capital typically comes from the founder of the company and their friends and family. A seed stage is the first round of capital that is put into a business. This refers to a round that comes before any large investment rounds have been taken on. It is often during the pre or low revenue stages of a company. The capital is typically used to help generate more traction on a prototype or service until it can attract venture capital firms (VCs). 

Note: Sometimes seed capital from friends and family can also be referred to as friends and family round OR pre-seed round. There are some firms, angels, or venture capital firms that invest in seed rounds.

Valuation:

The startup valuation of your company represents how much someone other than you thinks it’s worth. We say “someone other than you” because while you may be the person who sets the valuation until someone else agrees that the price is valid, and writes you a check based on that valuation, it’s not validated. Valuation will be a common term you hear among angel investors. There are two ways the valuation is represented:

  1. Pre Money Valuation:
    This is how much the company is worth before an investor puts money into your company. So if you set your valuation to be $2 million, and the investor puts in $500,000, your pre money valuation is $2 million.
  2. Post Money Valuation:
    This is how much the company is worth after an investor puts money into your company. So if you set your valuation to be $2 million, and the investor puts in $500,000, your post money valuation is $2.5 million. You just tack on their investment to the valuation.

Term Sheet:

A term sheet is a non-binding outline of the terms and conditions in which an investment is to be made. It’s similar to a Letter of Intent in that it indicates a strong interest to move forward, but it’s not the same as guaranteeing an actual deal gets done.

Annual Recurring Revenue (AAR):

Annual recurring revenue (ARR), sometimes referred to as annual run rate, is the normalized annual revenue from your existing subscriptions. It gives you an overview of how your business is performing year on year, and enables you to more accurately forecast your growth.

Monthly Recurring Revenue (MRR):

Monthly recurring revenue (MRR), sometimes referred to as monthly run rate, is the normalized monthly revenue from your existing subscriptions. It gives you an overview of how your business is performing month to month and enables you to more accurately forecast your growth.

Convertible Note:

A convertible note is a loan made to a company that can be converted into stock by the choice of the issuer or holder at certain events. Each note has an interest rate, a maturity date,and may come with the option to convert at a discount at a future round or time.

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 (or stock options) 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 & 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. Employees usually hold Common Stock or options for common stock. Common stock typically means you’re the last person to get paid in the event of a trade-sale or other liquidity event. How companies structure their classes of stock can vary widely and depends on the founders, the board, and investors. 

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 or 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 that you allocate a certain percentage of the company’s shares to a Stock Option Pool for future employees. Employee option pools help retain talent and reward employees for building a company from the ground up. Generally, the employee option pool is carved out of the founders portion. Stock Option Pools will range in size based on the trajectory of the company.

Stay tuned for next week’s post on crowdfunding. Now, get out there and make 2021 the best year you can! 

Looking for support? We are here to help.

SEED SPOT, a 501c3 nonprofit, is here to help. Check out one of our programs, like the 2-Day Launch Camp to start your impact-driven business or nonprofit.

Are you already in revenue or have a product on the market? We can help take it to the next level with access to investors, mentors, and key resources in the Impact Accelerator.

If you are looking for hands-on support and guidance, reach out and have a 15-minute phone call with a SEED SPOT Team member. As a nonprofit, we are dedicated to helping you start, grow, and scale your impact-driven venture and startup. Let’s chat!

C'pher Gresham

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