Ever felt overwhelmed by the terms and acronyms used in venture capital transactions? Whether you’re in the process of trying to secure funding for your startup, or you’re looking to invest in some promising new ventures, you need to learn the lingo. You don’t just need the textbook definition either – you need to know what the terms mean for your business, what questions to ask, and what pitfalls to avoid.
The term sheet is a document that specifies the investment amount the ownership claims the investor can receive, identifies roles and rights of the buyer and seller, and any other parties to the transaction. The term sheet is important because it is the first tangible piece of documentation to indicate that an investor is serious about your startup. Although a term sheet is not legally binding, except for clauses related to exclusivity and confidentiality, there are several important things you should do when evaluating a term sheet. The first is to consult a trusted financial advisor or attorney. Then, ask yourself these questions:
- Does it contain an accurate valuation of the startup?
- Are there future capital requirements buried in the provisions?
- What are the post-funding employment conditions?
Angel investors fill critical funding gaps at very early stages of growth. These kinds of investors are usually used when entrepreneurs need less than $1 million. Some angel investors are sophisticated, well-managed groups that have closed many transactions. Others mean well but are less likely to be versed in venture capital transactions. You should be concerned if a less experienced angel investor offers more than twice the price a professional investor would have.
Series A Financing
The first round of financing a new business seeks after obtaining seed capital. Usually, this is the first point in time that external investors have a chance to get in on the action. The new business is probably generating revenue but needs the Series A financing from venture capital and angel investors in order to keep growing and delivering value. Series A financing may or may not include the offering of preferred stock, but as the company grows and requires additional financing, subsequent rounds of funding will offer those additional investment options.
A capital call (drawdown) is a request to partners and shareholders to raise additional equity investment to make up for cash shortfalls. These funding shortfalls can commonly occur during critical stages of business development, such as initial product launch or first years of operation. A capital call allows a venture fund to acquire the resources it needs to draw on funds then, and in the future. Here’s how the move can be mutually beneficial for both entrepreneurs and investors:
• Confirms that investors are committed
• Sparks new investor interest
• Allows certainty entrepreneurs need to take on projects
A leveraged buyout, or hostile takeover, has become a popular practice since the dot-com collapse and the subsequent housing downturn and economic recession. In a leveraged buyout, the company that acquired the corporation usually privatizes it to gain additional control over management. Ultimately, the corporation that was bought out might be split and sold off, or dissolved. Unlike a merger, a leveraged buyout does not require the approval of stockholders or a vote by the Board of Directors.
The inner workings of venture capital are complex and commonly misunderstood. Working with a financial advisor or attorney can help guide you through the unknown steps in obtaining venture capital financing. But some of your best teachers will be your peers, who have struggled through their own challenges of securing funding and investing. Never underestimate the power of human capital.