Learning about venture capital terms can take a while and I have never come across a venture capital dictionary. There are a lot of terms to get your head around, especially when you are trying to get the best deal as an investor or startup founder.
List of the most important venture capital terms you need to know as an entrepreneur
With this in mind, I’ve put together a go-to list of the most important venture capital terms you need to know on your journey as an entrepreneur.
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Here is the content that we will cover in this post. Let’s get started.
Accelerator: A group, institution or program which offers guidance, networking, and infrastructure to companies in order to accelerate their growth. In return, the accelerator is given equity.
Accredited Investor: In certain markets and situations an investor must satisfy strict guidelines in order to be considered “accredited”. In the US, for example, an individual or group of investors must meet thresholds for net worth or income, as outlined in the 1940 Investment Company Act.
Acquisition: When a buying company purchases a controlling stake in a target business. When the board, shareholders, and managers of the target company approve of this deal, it is called a friendly acquisition. When one or more of these groups does not, it is called a hostile takeover.
Allotment: The process of providing new shares to shareholders. A shareholder’s allotment is the number of shares they are to be given.
Analyst: Part of a venture capital firm. Usually asked to carry out a preliminary analysis of businesses before a firm offers investment. This can involve projection analysis, early stress testing, market research, and other administrative duties.
Angel Investor: An individual investor who provides financing during a company’s earliest moments. This investment is usually offered in return for equity or convertible debt and is provided in order to get a company into shape for the next financing round (usually a seed round).
Anti-Dilution Provisions: An agreement protecting an existing investor’s share in a business. If new investors are brought in and given equity, the original investor’s equity is not diluted. They continue to own the same share of the business as originally agreed.
Articles of Association: A critical document that outlines the rights and restrictions attached to a company, as well as the said company’s share classes and share structure. This includes information about shareholder voting and selling rights.
Assets Under Management: This includes all financial assets managed by a venture capital fund.
Associate: A member of a venture capital firm. A step up from analysts, associates carry out more in-depth research and carry out due diligence.
B2B: Short for Business to Business. Simply refers to any company which does business with other businesses as their primary focus.
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Bad Leaver: This happens when an employee or staff member leaves a company and violates agreed procedures. When this occurs, the “bad leaver” disqualifies themselves from share or equity payouts. In extreme circumstances, they are not allowed to hold onto their existing shares or receive money for them. An example of a bad leaver would be an employee fired for gross misconduct or someone who resigns before an agreed date of departure.
Board of Advisors: A group of individuals who offer advice to the management of a company. This is an informal relationship and not legally binding, but can provide valuable strategic policies.
Board of Directors: Custodians of a company. The board of directors (“board” for short) looks after a company’s affairs and makes major decisions about its future. To have a seat on board usually requires investment. For that reason, most boards are made up of investors or investor representatives.
Bootstrapped: A business, usually a startup, which is funded purely by the main entrepreneur behind the business and/or any generated revenue.
Bonds: A form of debt investment. In this case an investor offers a loan to a business in return for bonds equalling that value. These can then be cashed in after an agreed amount of time, and at a specified rate of interest. Bond owners are therefore creditors rather than shareholders and have no say over a company’s strategies.
Bridge Loan: A loan that bridges a financial gap. Usually used to finance a business when it is in negotiations with a large investor, to keep the business running until new investment or revenue is generated.
Business Plan: A business plan is a systematic breakdown of how a business will develop. This clearly states any expenses needed to achieve specific goals within a given timeframe.
Burn Rate: This is one of the least underlooked items in this venture capital dictionary but also super important. This is, in essence, the amount of money a company is using over a specified time. For example, a monthly burn rate. Used by venture capitalists to gauge how sustainable a target company’s expenditure is.
Buyout: A way for an investor or founder to exit a business. It occurs when another investor offers to” buyout” another investor or founder’s shares to gain more control of a business.
Cap: A limit placed on any transaction, usually financial. This could be a cap on fundraising or expenditure. It could also be a cap on the price of shares or a cap on the number of products being manufactured.
Capital: This refers to monetary assets that a company, group, or individual has access to for business use. You might also hear the term “working capital” to describe this, though that is most usually applied to available cash.
Capitalization Table: A summary list for a startup. Includes investor and shareholder details such as their names, percentage of ownership, and any shares or stock class they own.
Capital Gains: Any profit made from the sale of property or an investment. Usually taxed by governments.
Carried Interest (Carry): A fee often charged by venture capital firm managers. Usually 20% of any generated profits. This incentivizes managers of venture capital funds to ensure that they are investing their clients’ money in profitable businesses. This 20% fee usually only happens if an investment performs beyond an agreed threshold.
Cash-on-Cash Return: How much an investment generates in relation to the original amount. For example, if an investor invests $10,000 in a business which is then later bought and they receive $100,000 in return – that is a cash-on-cash return of 1000%. Also known as Multiple on Invested Capital (MOIC).
CEO: A chief executive officer. Responsible for all managerial decisions, and ultimately in charge of the business unless removed by a board of directors.
Compliance: A company is in compliance when they follow all regulations and laws which are salient and binding.
Common Stock: when you are thinking about venture capital terms this, in essence, represents company ownership. Shares allow their owners to vote on corporate policy and to have a say on serving directors. If liquidation should occur, or a sale, common stock owners are only paid an amount after bond and preferred stockholders.
Completion Schedule: An agreed timeframe for completing all administrative and procedural tasks in order to sign off on investment.
Convertible Note: as shared in my book The Art of Startup Fundraising, this is a legally binding agreement that if an investor loans an agreed amount of money to a business, that it can be converted into equity at a later date. For example, an investor lends $50,000 to a business with an annual interest rate of 10%. After one year, the business performs a share issue, giving that investor shares equal to $55,000. That’s the original amount, plus the 10% accrued interest as equity.
Convertible Preferred Shares: An agreement where shareholders can convert their preferred shares into common shares. This usually has a specific time frame associated with it, such as two years after investment.
Corporate structure: A description of how each department (Marketing, Human Resource, Accounting etc.) within a business contributes to the overall vision and goals of the organization.
Covenant: A legally binding agreement. This agreement stops an individual from carrying out a specific act. For example, an investor could agree to invest in a company if the startup founder signs a restrictive covenant. This type of covenant means that if the founder sells its ownership in the future, they cannot set up a new company that competes with the original business.
Credit: Finances given or “loaned” to a business or individual, usually with a date of repayment set in stone. The credit becomes a debt and often has a percentage of interest placed on top of the original credit agreement or loan.
Creditor: Individual, group or organization that lends money to a business. The creditor is who the loan repayments should be made to.
Crowdsourcing: Innovative, hassle-free way to seek investment by using third-party companies such as Onevest to match your start-up with ideal investors.
Crowdfunding: When investors or interested parties pool their money together to support a financial venture. Rather than having one large investor buy a large stake in a company for $1million, 10,000 people could each invest $100 each. This stops any single group from controlling everything and is in some cases easy to secure than one large investment sum.
Cumulative Dividends: A payment made to shareholders for an agreed amount. This is either fixed or an agreed percentage of a share’s price. Cumulative dividends must be paid out to shareholders with preferred shares if the original share purchase came with that agreement.
Debt: Any finances or assets owed to a creditor.
Debtor: A business that owes a debt.
Default: Failing to make debt payments.
Demand Registration: Also known as Demand Registration Rights. Where an investor can force a private company to initiate an IPO or share issue so that the investor can sell their shares on an exchange. Usually only applies to common stock.
Dilution: When an existing investor or founder’s share of a business is diluted. This happens when new investors buy up equity or shares and there is no anti-dilution agreement in place. This reduces the fraction owned by current investors/founders. This is a critical term in this venture capital dictionary.
Disruptor: Any innovation in a marketplace that disrupts the existing way of doing things. This can be through new technologies that leave existing ones obsolete, finding a new demographic for a niche, or altering the price point usually associated with an existing marketplace.
Dividends: Profits paid to shareholders. A dividend in kind is the payment of assets instead of cash.
Down Round: If new investors buy shares at a value lower than a previous fundraising round or share-issue, then this is called a Down Round.
Drag-Along Rights: Force’s minority shareholders to back the sale of a company. Usually forced through by shareholders holding anywhere from 50% to 75% of the stock.
Due Diligence: A complete financial and legal assessment of a business or deal before purchase. Only through due diligence can a buyer know exactly what they are buying and its robustness.
Dynamic Equity Split: Co-founders or investors are rewarded new shares in their business dependent on their performance. The more someone contributes, the more they earn.
Enterprise: A company or business.
Entrepreneur: Someone who starts a business.
Entrepreneur in Residence: A successful entrepreneur who is hired by a venture capital firm to identify future investment opportunities. They may offer mentorship to the firm’s portfolio of companies.
Equity: A portion of a company. Someone who owns equity owns a percentage of a business through shares or an agreement to be given shares at a later date.
Exit: The end-goal for most investors. How an investor sells their share of a business, hopefully for as high a profit as possible.
Fair Market Value (FMV): After analyzing a business, this is the amount an independent third party assessor believes a company’s shares are worth. When you are thinking about the venture capital dictionary or terms this one really comes into play when doing a 409A Valuation.
Financial Forecast: Also known as a financial projection, a forecast estimates growth and income for a business over a given time, based on comparison with existing businesses and market research.
Founder: The person or people responsible for the creation of a company.
Funds of Funds (FoF): A fund that invests in other funds. Imagine a venture capital group that invests in other venture capital groups.
Future Proof: Projecting into the future and protecting a business or product so that its fundamental design will keep it competitive in the future.
Ground Floor: When an investor has the opportunity to be part of a company from its first, initial moments.
Harvest Period: This is the period where a venture capital firm starts to generate returns on its investments. Usually results from an IPO, merger, acquisition, or new product launch.
Incubator: Similar to an accelerator. An organization that offers assistance to startups so that they may reach their initial investment rounds.
Initial Public Offering (IPO): The first sale of shares traded openly on a public exchange.
Internal Rate of Return (IRR): As part of this venture capital dictionary this is a calculation of how much money is returned on investment annually. Venture capital firms expect to see larger returns over longer periods, and so if an investment’s IRR diminishes over time, VCs may sell their shares in order to free up investment for more lucrative ventures.
Investment Period: The time taken for a venture capital firm to invest its funds across its portfolio companies. Most venture capital funds have invested all their capital after 3 – 5 years.
J-Curve: When the IRR (See Internal Rate of Return) of a venture capital fund is plotted on a graph, it should resemble a J as profits grow.
Kamikaze Defense: A last-ditch defense against a hostile takeover where a company carries out strategies to reduce its operational or financial worth. The end result is that this may make a business less attractive to investors.
Limited Partner (LP): An individual or entity such as a pension fund or insurance company which contributes capital to a venture fund.
Liquidation: When a company is dissolved and its assets are disposed of or sold.
Liquidation Preference: A clause in a contract which stipulates which investors receive payment first if a company is liquidated or sold, even before a company’s founders in many cases. This is a common clause often used by venture capitalists to off-set the risk of investment.
Liquidity Event: Any event which results in liquidation, such as defaulting on debts.
Market Research: A way to define consumer wants and needs. By carrying out market research studies, a start-up can then streamline its approach to be more appealing to a target demographic.
Market Value: The amount an investor or consumer is willing to pay for something based on current consensus about how much a company, product or service is actually worth.
Mezzanine Level: Companies which are beyond the startup phase, but not fully mature. Even though this is included in this venture capital dictionary this tends to be for more later-stage companies.
Non-Disclosure Agreement (NDA): An agreement that anything mentioned between two parties cannot be disclosed with others. This includes product information and other sensitive data. For example, if a VC firm carries out due diligence into a target company, they may have to sign an NDA so that, even if they do not make a purchase, they cannot use the information they discovered during this process. Keep in mind that even though this is included in this venture capital dictionary, VC firms hate to be presented with NDAs right away for just intro meetings.
Outsourcing: Hiring a freelancer to complete a task for your business rather than you or your employees doing it. A Common practice to reduce overheads and secure quality work without requiring full-time staff.
Option: Similar to right of first refusal.
Pari Passu: Term used during negotiations. It means side by side or at the same rate.
Pivot: A quick change in business strategy. Often occurs when a startup shifts its attention to a new niche or product type.
Portfolio Company: A company in which a venture capital firm has invested, adding it to their portfolio.
Preferred Stock or Share: This type of stock is rewarded with dividends before common stock.
Proof of Concept: Demonstrates that a product or service will work and be financially rewarding for investors. Most venture capitalists will expect this before investing.
Prospect: Sales speak for any customer or investor who fits a demographic. A person who is most likely to make an investment when approached. Also known as a potential investor.
Pro-Rata Rights: Provides an existing VC investor with the option to increase his or her stake in a company during future fundraising stages.
Qualified IPO (Qualified Public Offering): A description of a future IPO of a company. When used, convertible equity securities convert into common equity. Also used to terminate stock transfer rights for specific investors if necessary.
Recapitalization: When a company restructures its capital, changing its equity and debt ratio.
Right of First Refusal: A contractual agreement that an investor will have the first option to buy shares or take part in another business transaction before being opened up to others. As part of this venture capital dictionary, this is an important term when you have a large corporation that wants to invest in your company as that could limit your potential outcome eliminating the possibility of a bidding war.
Return on Investment (ROI): The amount of profit an investor makes in relation to their original investment.
Seed Round: The first financing round for a startup. Often attracts angel investors. Precedes series or “round” A.
Secondary Public Offering: Takes place after an IPO. A share offering to the public, often when founders are looking to sell their stake.
Sector: A market niche where a business is looking to sell its products or services.
Series: A round of investment. Usually named A, B, C, and so forth.
Stage: The level of development of a startup.
Startup: A business at the beginning of its journey, usually the first couple of years.
Syndicate: A network of investors looking to invest during a specific fundraising round.
Tag-Along Right: A legally binding agreement that ensures minority shareholders have the right to sell their shares for the same value or terms as majority shareholders.
Term Sheet: Outlines the main points of investment, how it will be paid, what will be given in return, and what the investment will be used to achieve. Not legally binding, but provides a good foundation during negotiations.
Underwriter: An individual or firm who “underwrites” or assumes the financial risk for another party.
Valuation: When assessors, usually a third-party, calculate the value of a business through its assets, finances, revenue, burn-rate, and future projections.
Venture Capital: Pooled finances of a venture capital group currently available for investment.
Venture Capitalist: Individual, usually in tandem with a venture capital firm, who invests in companies, often within a specific niche.
Venture Partner: An individual brought in temporarily to assist a venture capital firm. Not a full partner, but may identify and facilitate new investment opportunities for a VC firm.
Vesting: Stock options provided to employees, usually as a reward for performance and duration of employment.
Warrants: A contract issued by a company allowing an investor to subscribe for shares at an agreed price during an agreed time frame.
Window: Time frame associated with a share option or investment opportunity. This term is super important in this venture capital dictionary as founders need to continue to create urgency or the fear of missing out.
XRT: An extension that appears after a ticker symbol on a listed stock. It means that the buyer of the stock cannot legally buy shares at a lower price because the rights to do so have now expired.
Yellow Knight: A company, investor, or VC firm that was going to carry out a hostile takeover but pulls out, offering a friendly merger instead.
Yield: Financial or asset measurement. Usually, the amount or percentage returned to an investor for their investment. Includes share sales and dividends. The earnings an investment generates over a specific period of time. For example, one quarter or annual yield. Even though this term is included in this venture capital dictionary this is not a typical term that early-stage companies would encounter.
Zone of Resistance: The upper limit for a share’s potential value. The lower limit is the Zone of Support. Understanding the zone between helps venture capitalists and other investors gauge a good time to buy or sell the stock.
In addition to this venture capital dictionary, remember that storytelling plays a key role in fundraising. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the pitch deck template created by Silicon Valley legend, Peter Thiel () that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
You may also find interesting the video below where I cover in detail how venture capital works.
FULL TRANSCRIPTION OF THE VIDEO:
Hello, everyone. Today, we’re going to be talking about venture capital firms and how venture capital works. Basically, the idea of, really, venture capital firms are the ones that are investing in startups. For the most part, in early-stage startups, you see them starting to invest at seed rounds, then they go to Series A, Series B, Series C, and then you start having private equity firms really coming in.
The main difference between the venture capital firms and the private equity firms is that the venture capital firms are investing in people, while private equity firms are investing in the numbers. When it comes to the actual venture capital firm, everything starts with the people, all the way at the bottom. So the people at the bottom really are the analysts. So those are the kind of people that are going to be crunching the numbers in the office, that are going to go to events, that are going to be cold emailing founders.
And by the way, if you receive a cold email from an analyst, don’t even respond because basically what’s happening is that what the analyst is doing is reaching out to get information from the market, specifically from the founders, so they’re able to then retrieve all that information, all that data, and identify different players in the market and potentially, the winner that the investment firm is going to be investing in. That’s going to start with the analyst.
The analysts don’t have any type of say or vote in the matter. They’re just crunching numbers and pushing paper. After the analysts, what you’re going to encounter are the associates. The associates, they start with the summer associates, for example, the people that are doing an MBA, and for the summer they want to work at a venture firm, and potentially become later on a fulltime associate.
Then you have the associates, again, people that are just coming out of college or coming out of their MBA, or maybe like a failed entrepreneur that has been given the opportunity by that fund that invested in them to come and work for them. Basically, the associates, they’re going to be scouting deals, they’re going to also go to events, and they are going to have the potential of opening the door for you to the partners, which ultimately are the ones making the decisions. However, the associates don’t have any say in the matter, and they’re not going to be able to make any type of investment decision. So do not waste your time so much with the associates.
The other guys that are going to be in-between the associates and the partners are going to be the principles. Now, the principles are those folks that may have a say in the matter, are those individuals that are seasoned, that have been working in venture capital for some time, or maybe they have exited a business in the past. Now, they’re working at the firm, and they’re helping with sourcing investments, with doing the due diligence on some of those investments, and then potentially have the opportunity to make decisions on some of those investments. But for the most part, principles do not have that much of a say when it comes to making the investment.
Outside of the principle, what you’re going to find is the partners. Now, the partners come in different types of flavors. The first one is going to be the normal partner. That partner is basically that one that is going to be receiving that deal flow, that is going to be involved in the socializing, into the screening, into the due diligence, and also into the term sheet process as well as the verification of whatever statements that have been made by the founder, which really is the due diligence, again, even though the due diligence really happens all across the board from the minute that you step your foot in the firm. The VC is going to start to really do the due diligence on you.
Basically, with that being said, the partner really is going to be someone at the beginning is going to be grabbing you—if they like you, they’re going to be grabbing you into the firm, putting you in touch with, let’s say like another partner so that they are already becoming your sponsor. They are helping you with introducing you to other partners so that potentially other partners are also easing to the idea of making an investment in you. Then, basically, the partners, they’re going to invite you for the partners’ meeting. And then, at that point, they’re going to decide whether or not they make an investment in your business.
The top partner is the managing partner. The managing partner, for the most part, is the real head guy. He’s also super-involved when it comes to the operations in the business and also that managing partner is going to be involved when it comes to raising money for their fund, and their fund is obviously raising money from their own investors, which the venture capitals call the limited partners or LPs.
Now, it’s very important for you to understand how the venture capital firms make money. Basically, what it comes down to is that they make a 2% management fee, on average, and a 20% carried interest. So there’s always a management fee on whatever assets that they’re managing over the course of time let’s say five or ten years. And also, they get the carried interest, and the carried interest, the way that it works, let’s say 20% is on whatever profit that they’re able to generate for their own funds.
Let’s take an example. For example, if they’ve raised a 100-million-dollar fund, and let’s say they’ve been able to do okay or they’ve been doing very well with the fund, and they made up to 200 million between the amount raised and then also the profits that they generated from the startups that they were able to exit, then basically what happens is that the first 100 million is returned to their investors, to their limited partners. And then from that remaining 100 million that they have made in profits, what’s going to happen is that they’re going to be taking the carried interest.
In a case where they’re making 20% carried interest on that extra 100-million on the profits, they will be taking 20 million themselves. The other 80 million is what they return back to their investors. They will be making money with that carried interest. Plus, let’s say if it’s a 100-million-dollar fund, if they’re making, let’s say, a 2% management fee, that’s going to be on a yearly basis, 2% on that, and that is distributed amongst the partners of the firm.
That, in a sense, is the way that venture capital firms work, and the way that you’re going to be seeing the structure of all these different players. Again, remember that the limited partners, which are the ones that invest in the actual fund, those do not have a say in the matter. Sometimes, they may sit on the investment committees that some of these venture firms have, but for the most part, the people that are making the decisions are the partners. That’s really the way that venture capital works.
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