Important startup terms to know (Part II)
The second part of this article explores more terms and keywords that are commonly used to describe people, systems, processes, activities and operations in startups.
According to Investopedia, Dilution occurs when a company gives new shares that result in a decrease in existing shareholders' ownership percentage of the company. Dilution also happens when holders of stock options like company employees exercise (sell) their options. Usually, when the number of shares outstanding increases, each shareholder owns a smaller percentage of the company, making the shares diluted. Simply put, dilution is the reduction of a shareholder's percentage in a company due to the issuance of additional shares.
2. Investor update
This is a report of a company’s key metrics, needs/ challenges and activities given to the company’s investors over an allocated period of time (can be monthly, quarterly or annually). Slidebean defines it as a way of keeping your ‘backers’ informed of your company’s processes and securing your startup’s wellbeing.
3. Cap table
A capitalization table, commonly known as a cap table is a spreadsheet that shows a company’s securities such as shares, warrants, the value of equity for each funding round, etc and includes ownership of these securities and the prices paid by investors for the listed securities. It details each investor's ownership percentage in a company, as well as its value and dilution over time. Cap tables are common with startups and early-stage companies. A cap table may also contain documents like stock issuances, transfers, and debt to equity conversation documents among others.
Cap tables can be managed on spreadsheets or cap table automation software for businesses with complex equity structures
4. Common stock
Common stock, also known as common shares, ordinary shares or voting shares refers to a security that represents ownership of equity in a company, giving the owner of the stock a right to share in company profits and exercise control over it by taking part in the election of the board of directors. Owners of common stocks can also vote on corporate policies
5. Financial forecast
Financial forecasting is a financial management and planning tool that helps businesses determine where they are headed, estimating the amount of revenue and income that will be made by the business in time to come. It projects a company’s future by using historical data; using previous financial data to estimate future returns and budgeting. Financial forecasting helps a company make adjustments to production and inventory levels. During a financial forecast, the income statement, revenue and operating profit are forecasted.
A SAFE (Simple Agreement for Future Equity) is an agreement between an investor and founder that gives the investor rights to future equity upon certain agreed events and terms. Unlike convertible notes, a SAFE document has no maturity date nor interest rate, it has an automatic conversion on any priced share issue and a valuation cap. A SAFE is a legally binding document that allows an investor to buy a specific number of shares at an agreed price/ rate at some point in the future.
7. Data room
Corporate Finance Institute defines a data room as a secure place that is used to store privileged data, usually for legal proceedings, or mergers and acquisition transactions. Data rooms are mostly used for document storage, file sharing and the conduction of financial transactions. Data rooms can be physical or virtual.
Physical data rooms involve the setting up of a physical location by the seller for the purpose of storing important documents needed for mergers and acquisitions. This is a part of the due diligence process during mergers and acquisitions and buyers and legal representatives of the buyer can access it before concluding the transaction. A virtual data room is a cloud solution for securing and sharing sensitive information. It facilitates the due diligence process of venture capital transactions, as well as mergers and acquisitions by giving potential buyers access to data through a secure internet or cloud connection. They can also be used during IPOs and court proceedings.
8. Down round
Down rounds occur in situations where a startup offers extra shares for sale at a lesser price than they had been sold for in the last financing round. This happens when a company discovers that more capital is needed for the business and that its valuation is less than it was in the last round. This makes them sell their stock at a lesser price, per share. Down rounds can impact ownership percentages, decrease business valuation and negatively impact company morale. Down rounds can occur when a company fails to meet revenue targets, increased market competition and also in cases when funding conditions change and are harder than it normally would be.
9. Pre-valuation revenue
This defines a phase where a business is not making revenue or profit yet. At this stage, the business is focused on building an MVP (Minimum Viable Product), using feedback from its customers to iterate and build a product consumers will be willing to pay for.
10. Sweat Equity
This refers to an individual or founder’s unpaid contribution, sweat or labour towards a business or project. Sweat equity cones in the form of mental effort, physical labour and time. For early-stage startups who have limited resources, compensation for sweat equity put in by employees can be exchanged for a stake or return in the company.
11. Valuation (Pre-money and Post-money)
Valuation is the process of determining the present (and sometimes expected) value of a company or asset based on different criteria like its management team, capital structure, current and projected revenue/ profit and the market value of assets among others. Pre-money valuation is the estimated worth of a company before it receives external funding or goes public. It is the total equity value of a business and not the share price. The pre-money valuation of a company can be given by a proposed investor, forming the premise for the amount of funding to be provided as well as the expected ownership percentage calculated on a fully undiluted basis.
Post money valuation is the estimated worth of a company after it receives a round of funding/ investment. It is used by venture capitalists to know the amount of equity needed in exchange for funding given to a business.
12. Customer evaluation
Also known as consumer testing or research, this involves the assessment of properties or performance of existing products or services as perceived by the customers. It measures how satisfied and happy consumers are with the capabilities, products and services of any company. This satisfaction can be captured through customer satisfaction score surveys (average rating of a customer’s response), net promoter score surveys (the probability that customers will give your company a referral), customer service data, and customer effort scores (which shows how easy it is for customers to do business with your company), etc.
13. Venture capitalist
A venture capitalist is a private equity investor (can be an individual or company) that provides capital to companies with high growth potential in exchange for an equity stake. This can take the form of funding a startup or supporting small companies that desire to expand but have no access to the stock market. They are important funding sources for financing startups and acquisitions. There are certain qualities venture capitalists look out for before investing in a business and they are highlighted in this article
14. Seed round
This defines the initial capital given to an early-stage business by an investor, for the purpose of developing the business idea. This funding is provided in exchange for equity or ownership and is often a small amount sufficient to cover only critical operation costs. Getting a seed round is the first of four funding stages needed for a startup to become an established venture. Seed round most times come from family, friends or acquaintances but can, however, also come from angel investors.
15. Series A, B, C
Series A refers to a significant investment put into a business venture after it has shown a certain level of progress in building out its model and has proven its ability to grow and generate revenue. This is put into a business after seed capital and investors in series A financiers (often venture capital and private equity firms) usually get large, controlling shares in the company (between 10-30%) in exchange for the money they are providing. Most series A investments come with anti-dilution provisions, and issued shares do not give their owners voting rights. Common objectives of series A funding include - growth achievement, product development and hiring. Here, preferred shares and convertible preferred shares are common tools used in exchanging money for equity.
Series B is the second round of funding for startups that have met stipulated milestones in the development and growth of the business such as revenue from sales. It is essentially the third stage of startup financing and the second stage of venture capital financing. In this funding round, convertible preferred stock and common stock are tools used in exchanging cash for equity. Financing for this round can come from venture capitalists, credit investments and crowdfunded equity.
In Series C funding round, the business to be funded is already successful as most of the companies at this stage are no longer startups. The funds gotten are then used for the development of new products, new market expansion and sometimes, acquisitions. The funds raised for this round are gotten through the sale of preferred shares. In this round, investors provide funding with the aim of receiving double of funds gotten sometime in the future. Hedge funds, investment banks, private equity firms, etc are common participators in this round. In typical scenarios, companies end external financing after this round. In some expectations, companies go on to raise Series D, E, etc rounds. Additionally, most companies will complete an IPO after their Series C funding.
16. Non-Disclosure Agreement (NDA)
A Non Disclosure Agreement is a contract signed between two or more parties that protects confidential information and interactions. NDAs are also known as confidentiality agreements and are often used during negotiations. They are used between 2 or more businesses and between companies and employees to protect trade secrets, marketing plans, manufacturing processes, etc.
17. SaaS (Software as a service)
SaaS is also called cloud-based software. It is a method of delivery that allows data to be accessed from any device with an internet connection and a web browser. In this model, access to the software is provided on a subscription basis and hosted on external servers. Common examples of SaaS applications include Gmail, Office365, etc.
EBITDA means Earnings Before Income, Tax, Depreciation and Amortization. It is used in measuring a company’s financial performance and ability to generate revenue. It is also used by valuators and businesses to compare a company’s financials to others in the industry, as well as its profitability. EBITDA is calculated using elements found in the income statement. It is net profit+ interest + taxes + depreciation and amortization. Interest here should include only short-term and long-term debts. Additionally, only income tax is to be added. EBITDA is used to measure the profitability of a business.
19. B2C/ B2B2C
B2C (Business to Consumer/ Customer) is a retail business model where goods move directly from the manufacturer to the end user. Business-to-customer transactions can happen traditionally (physically or in-person) or online (virtually, also known as eCommerce).
B2B2C is an eCommerce model that combines both business-to-business and business-to-customer models for a full and complete product/service transaction. Liferay defines it as an eCommerce model where businesses access customers through a third party but are unable to interact directly through their own brand. For this, a business partners with another business to provide a product or service to customers. For example, a financial institution may partner with agent bankers to provide mobile money or POS services to customers.
This occurs when a company buys the majority or all of another company’s shares to get full control of that company. In most situations, buying 50% of a company’s assets or stocks gives the acquirer or buyer decision-making power in the company, without the approval of other shareholders. Acquisitions occur for various reasons which include the need for diversification and bigger market share, market expansion, cost reductions and growth strategy purposes.
21. Return on Investment
ROI is a performance metric used by investors to measure the profitability of an investment or asset purchased. It is also used in the development of business cases for different proposals and for comparing varying investments in a portfolio.
It calculates the returns on a specific investment in relation to the cost of the investment. It is derived by calculating the return on an investment divided by the cost of the investment and expressed in ratio or percentage, that is net income divided by the capital cost of investment. ROI can also be referred to as return on cost.
Crowdfunding is the use of small amounts of money from a large pool of individuals to fund a new business venture. It employs the use of social media and crowdfunding websites to bring investors and founders together creating more room for founders to get investment aside from family, friends or venture capitalists.
23. MVP (Minimum viable product)
This defines the initial version of a product built with just basic features to be usable by early and initial customers, who will then give feedback for future product development. The essence of a minimum viable product is to validate a product idea early in the product development cycle, using customer feedback to iterate and improve the product. It also allows the product team to learn about their customers with the least amount of effort. Some of the purposes for shipping the minimum viable product include- Accelerating learning, reducing wasted engineering hours, building a brand quickly, finding a base for other products, etc
24. Customer Acquisition Cost (CAC)
Customer acquisition cost measures the cost of acquiring new customers. It is the total cost of sales, marketing efforts, incentives or equipment used in converting a lead to a customer. Customer acquisition cost helps an organization to know the overall value of a customer and the return on investment on acquisition. It is derived by calculating the cost of sales or marketing divided by the number of customers acquired over a period.
25. Debt fund
According to Investopedia, a debt fund also known as credit funds or fixed income funds is an investment pool such as a mutual fund in which core holdings are made up of fixed income investments or securities. A debt fund may invest in short-term or long-term bonds, money market instruments or floating debts. The core purpose of investing in debt funds is to get a steady interest income and capital appreciation.