Investing in startups requires intelligence, preparation and diligence, along with evaluating and spotting great concepts, teams and opportunities. It also frequently requires learning a few new terms. For those new to early-stage investing, here’s to get you started:
Cap table - A capitalization table (or cap table) is a table providing an analysis of the founders' and investors' percentage of ownership, equity dilution and value of equity in each round of investment. A cap table provides a record of all the major shareholders of a company, along with their pro-rata ownership of all the securities issued by the company (equity shares, preferred shares and options), and the various prices paid by these stakeholders for these securities. How to make a cap table
Term sheet - A non-binding agreement setting forth the basic terms and conditions under which an investment will be made. A term sheet serves as a template to develop more detailed legal documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is then drawn up. (Wondering what a term sheet in KC looks like? Wonder no longer!)
Burn rate – The rate at which a company expends net cash over a certain period, usually a month.
Pro forma - A Latin term meaning “for the sake of form.” In the investing world, it describes a method of calculating financial results in order to emphasize either current or projected figures.
Common stock - A security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure.
Preferred stock - A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.
Go to Investopedia for a description of the difference between preferred and common stock.
Anti-dilution provision - A provision in an option or a convertible security. It protects an investor from dilution resulting from later issues of stock at a lower price than the investor originally paid. Also known as an “anti-dilution clause.”
Guaranteed return - A return that a company is required to pay. Bonds and coupons have guaranteed returns because the issuing company agrees to pay coupons and guaranteed dividends. This contrasts with non-guaranteed returns, such as the dividends on common stock, which a company may decide not to pay. A guaranteed return does not necessarily mean that the company will pay (the company may default or go bankrupt). However, under some circumstances, the holders of securities with guaranteed returns my force the liquidation of the company.
Convertible debt - In finance, a convertible bond or convertible note (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value.
Option pool – The number of shares set aside for future issuance to employees and non-employees. A new company, which has not hired key employees other than the founders, may wish to set aside up to 15-20 percent of its common shares for issuance to employees, board members, consultants and other key individuals as part of their compensation and as an incentive to grow the company.
Run rate -The estimation of future financial data that assumes present trends continue. For example, if a company earns $1 million in a month, it may announce $12 million estimated annual earnings according to the run rate. This can be very inaccurate, particularly if a company's performance is seasonal.
Cash flow - The total amount of money being transferred into and out of a business, especially as affecting liquidity. Cash flow is the difference between the available cash at the beginning of an accounting period and that at the end of the period. Cash comes in from sales, loan proceeds, investments and the sale of assets and goes out to pay for operating and direct expenses, principal debt service and the purchase of asset.
EBITDA - Earnings before Interest, Taxes and Amortization (EBITA) refers to a company's earnings before the deduction of interest, taxes and amortization expenses. It is a financial indicator used widely as a measure of efficiency and profitability.
Discounted cash flow - DCF is a valuation method used to estimate the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate, which is used to evaluate the potential for investment. In simple terms, discounted cash flow tries to work out the value of a company today, based on projections of how much money it's going to make in the future. DCF analysis says that a company is worth all of the cash that it could make available to investors in the future. It is described as “discounted” cash flow because cash in the future is worth less than cash today.
Many thanks to Investopedia for help with definitions. To learn funding stage definitions, go here.
For more information on investing, head to Enterprise Center in Johnson County’s Angel Series of classes, plug into NetWork Kansas or give KCSourceLink a call at 816.235.6500.