Business Vocab

Liquidation Preference

The amount that must be paid to the preferred stock holders before distributions may be made to common stock holders. The liquidation preference is payable on either a liquidation of the company, asset sale, merger, consolidation or any other reorganization resulting in the change of control of the startup. It is usually expressed as a percentage of the original purchase price of the preferred, such as "2x." Thus, if the purchase price of the preferred is $5 per share, a liquidation preference of 2x will be $10 per share. Multiple liquidation preferences, for each investment series is possible.

Earlyvangelist

The customers who commit to buying a company's product before there is a full product available and spread the news of the product to friends, family, or coworkers.

Burn Rate

The rate at which a startup goes through its cash to cover expenses. A burn rate measures how quickly a startup company will use up its cash.

Non-Participating

Used generally in terms of preferred stock and its liquidation preference, means that the investor who chooses to receive its liquidation preference does not get to participate pro rata with the other stockholders in the remaining sale proceeds (after payment of the liquidation preference).

Incubator

A broad term which includes a variety of different types of companies and/or facilities whose purpose is to host and support the development of startups. Incubators help startups grow while controlling costs by offering networks of contacts and mentors, and shared backoffice resources. They will also generally invest a small amount of capital into the startup for a certain percentage (usually pretty small) of equity.

Preferred Stock

A class of stock that provides certain economic and control rights and protections not given to the holders of a startup's common stock (the founders usually hold common stock). Hence this class of stock is "preferred" to the common stock of the startup.

Convertible Note

A debt instrument that can be converted into equity automatically upon certain conditions and/or at the option of the holder or the issuer. Although not the main purpose of investing in Convertible Notes, they do earn interest, and 2-8% is standard. Usually, the investor will convert the principal of the note plus the interest automatically into equity when an institutional investor (such as a Venture Capitalist) makes an investment of a certain threshold amount. Convertible Notes are generally converted into equity with a conversion discount or price cap mechanism.

Term Sheet

A document confirming the intent of an investor and a startup to close a round of funding. The Term Sheet contains an outline of the main terms and conditions of the financing. Once executed, the startup and investor agree to begin the legal and due diligence process and create the definitive documents.

Bylaws

A legal document that determines the corporate governance of the startup. The bylaws are the rules and regulations for the startup's internal administration and management. Startups often fail to draft bylaws, as bylaws aren't submitted to the secretary of state.

Certificate of Incorporation

A legal document that is filed with the secretary of state to create a corporation. Certificate of Incorporation will contain the corporation's basic information (name, registered agent, office address, share structure, etc.). Certificate of Incorporation is also commonly referred to as a "Charter" or an "Articles of Incorporation."

Lean Startup

A method for developing businesses and products in which startups can shorten their product development cycles by adopting a combination of business-hypothesis-driven experimentation, iterative product releases, and validated learning.

Validated Learning

A process in which one learns by trying out an initial idea and then measuring it to validate the effect.

Common Stock

A type of equity security in a startup company. Common Stock is typically issued to startup founders, management, and employees. Investors are issued preferred stock if the investment structure is equity (rather than debt).

Fund

A vehicle by which multiple people can invest. Funds usually allow for diversification of investment, a prime example being a mutual fund, which allows for lower risk. Funds are also the investment vehicles used by both VCs and Private Equity firms, or even angel investors. A fund is usually an limited partnership or an LLC.

Option Pool

An amount of a startup's common stock reserved for future issuances to employees, directors, advisors, and consultants. These issuance typically take the form of stock options. The option pool is created pursuant to a written plan in order to satisfy Rule 701 which provides a registration exemption from Section 5 the 1933 Securities Act. Via the written plan, a startup pre-authorizes a certain amount of the company's common stock which will be issued by the plan's administrator (usually the startup's board of directors or a committee selected by the board). For example, if the startup has 5,000,000 shares of common stock outstanding, it may elect to authorize 1,000,000 shares to be issued pursuant to the plan. An option pool is typically created at each round of venture capital financing.

Control

An entity occurs when an individual or other entity owns more than a majority (usually 50% but sometimes set higher) of the equity of a company or owns the largest percentage of shares when compared to all other shareholders.

Split Test or A/B Test

An experiment in which different versions of a product are offered to customers at the same time.

Due Diligence

An investigatory process performed by potential investors or acquirers to assess the viability of an investment or acquisition and the accuracy of the information provided by the target corporation.

1X

Expression for a "one times original purchase price" liquidation preference. 1X is the multiple.

Liquidation

Generally occurs in the context of a startup selling off all assets prior to cessation of operations due to bankruptcy or simply going out of business. In a liquidation, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common stockholders. Once all debts have been paid, the remainder, if there is anything left over, is distributed to the stockholders.

Convertible Security

Investment that can be converted into another form. The most common Convertible Security is the convertible note which usually will convert into stock upon certain occurrences. Sometimes the convertible security is simply titled "Convertible Security".

Pre-Money Valuation

Is the startup company's value immediately before a round of financing. A pre-money valuation is used to determine how much equity an investor is seeking in return for his or her investment. Pre-Money Valuation = Post-Money Valuation - Investment

Actionable Metrics

Measurements that give a cut-and-dry picture that accurately reflects the key drivers of a business.

Vanity Metrics

Measurements that give the rosiest picture possible but do not accurately reflect the key drivers of a business.

Protective Provisions

Rights given to investors, usually tied to preferred stock, that allow for the investor to approve certain proposed corporate transactions.

Minimum Viable Product (MVP)

version of a new product which allows a team to collect the maximum amount of validated learning about customers with the least effort.