Stock, performed by qualified valuation experts, to determine the Fair Market Value of the company Stock. What is a 409A Valuation and Why is it Necessary?
83(b) Election: A tax election on Restricted Stock subject to Vesting, whereby a Service Provider can elect to be taxed on the Restricted Stock “early”—that is, on its grant or purchase date, rather than on its vesting date. Tax Implications Related To Shares That Vest and 83(B) Elections
Accredited Investor: An individual or a business entity that satisfies at least one requirement regarding their income, net worth, asset size, governance status or professional experience, as defined under the Securities Act of 1933, as amended, and the rules promulgated thereunder. What is an Accredited Investor?
Accruing Dividends: A Dividend that automatically accrues to be paid out upon a specified event such as an Acquisition or IPO. For example, if a Stockholder purchases Shares for $100 and the Shares provide for a 5% Dividend, then the Stockholder would accrue a $5 Dividend each year that would be paid to such Stockholder upon an Acquisition, sale or IPO.
Acquirer: Another name for a Buyer of a company.
Acquisition: The purchase or sale of a company.
Advisor: A person who is not an Officer, Director or Employee of the company but provides the company with strategic advice. Advisors should execute an advisory or Consulting Agreement, which typically provides for confidentiality, Intellectual Property Assignment and an Equity Grant that will vest over the period he or she serves as an Advisor.
Advisory Board: A group of subject matter experts providing a company with guidance. Though they provide management with advice, they are purely Advisors and do not possess the authority to vote on corporate matters.
Angel Investor: High net worth individuals and entrepreneurs, particularly in the technology and life sciences industries, who use their industry knowledge, connections and expertise to make investments in start-up companies. Angel Investors are typically willing to take more risk than Venture Capitalists on very early stage ventures. Angel Investors are typically sophisticated and "accredited investors" under federal and state securities laws.
Anti-Dilution Provisions: These provisions adjust the number of Shares of Common Stock into which Shares of Preferred Stock convert in the event of a Down Round Financing or other Stock Dilution. The purpose of these provisions is to protect Investors’ Stock ownership percentage in a company. See also Broad-Based Weighted-Average Anti-Dilution and Full Ratchet Anti-Dilution.
Assignment: The transfer of an agreement or other rights to a new party.
Audit: An independent examination of a company’s financial health performed by a qualified accounting firm. It is designed to ensure the Financial Statements and reporting, books and accounts of the company are properly maintained.
Authorized Shares: The maximum number of Shares that a company may legally issue under its governing documents. The number of Authorized Shares of a company is set forth in the company’s Certificate of Incorporation. The number of Shares that are issued and outstanding is a different concept than the Authorized Shares.
Balance Sheet: A Financial Statement that reports the assets, liabilities and stockholders’ equity of a company at a specific point in time.
Basis: The cost Basis of an investment is the original purchase price adjusted for stock splits, Dividends and capital Distributions. Basis is used to calculate gain (or loss) for tax purposes.
Board Committee: A subgroup of the Board of Directors that is authorized to make decisions on specific matters, such as Audit or compensation matters.
Board of Directors: The Board of Directors determines the company’s strategy and direction and oversees the company’s management. Directors have Fiduciary Duties and must act in the best interests of the company and its Stockholders. The Board of Directors in turn elects Officers who manage and conduct the day-to-day business operations of the company. Board Membership and Roles
Board Meetings: Meetings of the Board of Directors. Board Meetings can be regularly scheduled, or can be a special meeting, which must be called according to the company’s Certificate of Incorporation and Bylaws.
Board Votes/Board Resolutions: The votes of the Board of Directors may occur in person or on a call pursuant to a Board Meeting, or by unanimous Written Consent.
Bridge Financing: Typically, a Convertible Debt Financing which provides the company a sufficient cash Runway or “bridge,” until the next Preferred Stock Financing.
Broad-Based Weighted-Average Anti-Dilution: This form of anti-dilution protection falls into the general category of “price-based” anti-dilution. Price-based anti-dilution protection means that if the company issues Securities in the future (other than certain Securities that are explicitly carved out) at a price that is dilutive to (i.e., less than) the price of the Preferred Stock that have the anti-dilution protection, then the conversion price (and hence the Conversion Ratio) of the Preferred Stock will be adjusted according to a price-based formula.
The broad-based weighted-average formula is the most common price-based Anti-Dilution Provision in the emerging growth world. The reference to "broad-based" means that the categories of outstanding company Stock included in the numerator and denominator of the formula are broadly defined to include Common Stock, Preferred Stock, Warrants and Options. The more Stock that is reflected in the formula, the less the anti-dilution adjustment. Therefore, the company will seek to broaden the definition to include the Common Stock issuable upon conversion of the Preferred Stock, the Common Stock issuable upon Exercise of outstanding Stock Options, the Common Stock issuable upon exercise of Warrants to purchase Common Stock and the Common Stock issuable upon conversion of Preferred Stock issuable upon Exercise of outstanding Warrants to purchase Preferred Stock. The Investor, however, may attempt to narrow the definition by excluding one or more of these categories.
Broker Dealer: A person or firm in the business of buying and selling Securities for its own account or on behalf of its customers.
Burn Rate: The rate at which a company is using cash, usually measured by the month. For example, a company with a $100,000 monthly Burn Rate is spending $100,000 a month more than it is taking in from Revenues.
Buyer: Another name for an Acquirer.
Bylaws: The internal rules by which the company operates. These rules include procedures for board and Stockholder meetings, Quorum requirements, action by Written Consent, Director powers, Director election and voting, creation of committees, Officer roles, Officer election and term, issuing Stock, restrictions on transfer, indemnification, notice of electronic transmission, voting regulations and day-to-day guidance. If there is a conflict between the Bylaws and the Certificate of Incorporation, the Certificate of Incorporation governs.
Corporation: A legal structure in which the owners, or Stockholders are shielded from the liabilities of the entity and taxed separately from the entity. Corporations are also subject to corporate income taxation. The taxing of Profits from the business is at both corporate and personal levels, creating potential double taxation.
Capitalization Table (Cap Table): A record of the ownership of a company and will include, at a minimum, each owner’s name, number of Securities and type of Security the owner possesses. A cap table provides a snapshot of a company’s Equity capitalization at any given time, so it is clear who owns each class of Securities and the total ownership of each owner. What is a Capitalization Table and what information does it typically include?
Capital Gain: A gain from the sale or exchange of a capital asset, such as Stock, that is taxed at a special, lower rate instead of the ordinary income tax rate.
Certificate of Incorporation: A document filed with the secretary of state of the state of Incorporation that establishes its existence. It includes the company name, registered agent’s name and address, authorized classes of Stock (typically just Common Stock at the time of Incorporation), the Par Value of the Stock and the name of the incorporator. The certificate can also include other information including the purpose of the company, the extent of indemnification of Directors and Officers and the process for election of Directors. In connection with a Financing, it will typically be amended and restated to authorize the new Shares being sold as well as the rights of those Shares. Also referred to as the articles of incorporation, certificate of formation or the corporate charter.
Chief Executive Officer (CEO): A company’s highest-ranking executive Officer, who is in charge of managing the day-to-day operations of the company. In emerging growth companies, one of the Founders is usually the CEO and a member of the Board of Directors.
Chief Financial Officer: The company’s Officer that is in charge of the company’s finance and accounting activities.
Cliff Vesting: The period of time before the first Tranche of Options, Stock or other Equity award vests. For example, there is often a one-year “cliff” for Employee Stock Options, meaning that the Employee must be with the company for a year to vest the first Tranche of Stock. What are typical vesting terms for employees?
Co-Sale Rights: Contractual rights often provided to Investors in connection with a Venture Capital Financing. The rights provide that certain Stockholders agree not to sell any of their Stock in the company without giving the Investors the right to participate in the sale pro rata to their ownership of Shares.
Common Stock: Represents Equity ownership in a company and typically has the statutory right to vote on certain corporate matters, including the election of Directors. Common Stock has fewer rights and is subordinate to Preferred Stock in an Acquisition or similar transaction. Founders of a company are issued Shares of Common Stock when the company is first formed.
Common Stockholder: A person who holds Common Stock.
Confidentiality Agreement: An agreement which binds one or more parties to non-disclosure of confidential or proprietary information. A Confidentiality Agreement can be one-way, meaning only one party is providing confidential information, or it can be mutual, meaning both parties are providing confidential information.
Consulting Agreement: A written contract that outlines the terms of the services to be provided by a consultant or Independent Contractor to the company.
Conversion Ratio: The Conversion Ration represents the number of Shares of Common Stock issuable upon conversion of one Share of a particular series of Preferred Stock. Typically, the Conversion Ratio is initially 1:1, meaning that one Share of Preferred Stock is convertible into one Share of Common Stock. This ratio can be adjusted as a result of stock splits, Dividends, recaps and the like or in connection with future Stock issuances that trigger Anti-Dilution Provisions.
Convertible Debt: Debt issued by a company which is convertible into Stock.
Copyright: A right that automatically vests to someone who authors an original work, including a literary work, song, movie or software. Copyrights are protected under the U.S. Constitution in order to protect the creative works of authors. A Copyright owner may register his or her work with the U.S. Copyright Office, or place a Copyright notice on the work, however, this isn’t a requirement. Typically, a Copyrighted work is protected for the author’s life plus an additional seventy years.
Covenant: A promise to do or not do something. A party’s failure to abide by the terms of a Covenant will result in a breach of contract.
Crowdfunding: The process of raising small amounts of capital from a large number of people. Companies can use Crowdfunding portals to raise the capital. There are restrictions on who can fund and how much they are allowed to contribute.
Data Room: Where a company’s Due Diligence materials are located for review by potential Investors, acquirers and their representatives.
Delaware General Corporation Law (DGCL): Title 8, Chapter 1 of the Delaware Code, which governs corporate law in the State of Delaware.
Demand Rights: A type of Registration Right. Demand Rights give the Investors the right to force the company to register Shares so the Stockholders can sell them without restriction.
Dilution: Dilution occurs when the percentage of an Investor’s ownership in a company decreases because the company issues additional Equity Securities.
Direct Listing: An alternative to an Initial Public Offering where a company’s Shares are registered for resale with the SEC and listed directly on a national securities exchange without an underwritten primary or secondary offering of Shares.
Director: Someone that sits on a company’s Board of Directors.
Disclosure Schedules: A component of a purchase agreement, including merger agreements, stock purchase agreements, note purchase agreements and asset purchase agreements, that provide fact-specific exceptions to the Representations and Warranties contained in the purchase agreement.
Distribution: Delivery of a kind of value to the Stockholders of a company, such as a cash Dividend.
Dividend: A Distribution of cash or Stock to Stockholders from the company’s Profits or Retained Earnings.
Down Round Financing: When a company sells additional Shares at a price less than the price paid by Investors in a prior Financing of the company.
Drag-Along Rights: A provision or clause in an agreement that enables a group of requisite Stockholders to force minority Stockholders to join in the sale of a company.
Due Diligence: When parties to a transaction conduct a business, legal and financial investigation of the company in preparation of a possible Financing, Acquisition or Public Offering.
Due Diligence Request: A request for information about the company by Investors or Buyers to conduct their Due Diligence.
Duty of Care: A Fiduciary Duty that requires members of the Board of Directors to use the same degree of care as a reasonable businessperson would in the conduct of his or her own business affairs.
Duty of Loyalty: A Fiduciary Duty that requires members of the Board of Directors to at all times act in the best interest of the company. Additionally, it imposes on the Director a responsibility to avoid potential conflicts of interest.
Member LLCs (which use the tax ID number of their owner). An entity can apply for an EIN through the Internal Revenue Service.
Employee: A person employed by the company for wages or a salary where the company has control over the scope of activities and how the activities are completed. There are important legal differences between the treatment of an individual as an Employee rather than as a consultant or an Independent Contractor, and it is important to not mischaracterize individuals that should be Employees as consultants or Independent Contractors.
Employment Agreement: An agreement which typically includes provisions for compensation (cash and Equity), bonuses and severance pay. Employment Agreements are not typical at early stage companies, which instead usually use Offer Letters.
Equity: A security representing an ownership interest in an entity. For example, Stock represents a Stockholder’s ownership in a company.
Equity Allocation: The amount of Equity each person will receive. In Startups, Equity will need to be allocated among the Founders during the formation of the company.
Equity Financing: The process of raising capital from Investors through the sale of Stock, usually Preferred Stock.
Equity Incentive Plan: An equity compensation plan or Equity Incentive Plan authorizes the company to grant different forms of Equity, including Stock Options and Restricted Stock, to Employees and other Service Providers. A Stock Option Plan is a form of an Equity Incentive Plan.
Exclusivity: In a Term Sheet for certain transactions, including Financings with Lead Investors or in a sale transaction, there is typically a requirement that for a limited time period, one or both parties exclusively negotiate with each other. These Exclusivity provisions are included so the time spent on negotiations and Due Diligence are not wasted by an interloping offer.
Exercise (a stock option): To purchase the Stock underlying a Stock Option.
Exercise Price: The price per Share for which the underlying Stock may be purchased by the holder of the Stock Option when Exercising the Option. The Exercise Price is typically equal to the Fair Market Value of the Stock on the date the Option is granted, which may be significantly less than the Fair Market Value of the Stock when the Option is Exercised. This is also sometimes referred to as the “strike price.”
Exit: The opportunity for Stockholders to sell their ownership to another party for cash or other value. Typically, an Exit in a Private Company occurs through a sale of the entire company or an Initial Public Offering.
Fair Market Value: The current value that a third party would pay in an “arm’s length” transaction for Stock.
Fiduciary: A person or organization that acts on behalf of a third party and is subject to a legal obligation to place the interests of the third party before its own interests.
Fiduciary Duties: Directors and Officers of a company serve as fiduciaries for the Stockholders of the company and owe Fiduciary Duties to the Stockholders, including the Duty of Care and the Duty of Loyalty.
Financial Statements: A company’s Income Statement, Balance Sheet and Statement of Cash Flows. Financial Statements may or may not be Audited.
Financing: A transaction in which the company issues debt or Equity to Investors in exchange for funds.
Finder: Someone who uses his or her connections to help find Investors for a Financing. Should I Use a Banker or Finder to Raise Money?
Founder: A non-legal term referring to one of the initial Stockholders of the company that has Intellectual Property or other valuable ideas and contributions in the beginning stages of the company. Additionally, Founders typically serve as initial Directors and Officers of the company. Does the Term “Founder” have any legal significance?
Founders’ Shares: Stock issued to the Founders of the company. Founders are typically Issued Shares of Common Stock.
Franchise Tax: A tax paid by a company for doing business in a state. When are annual reports due for a Delaware Corporation?
Fully Diluted Capitalization: The total capitalization of the company that includes both the Outstanding Shares and all Options (including Options that have not yet been granted), Warrants and other convertible Securities.
For example, Founder A and Founder B have been granted 4,000,000 Shares and 3,000,000 Shares, respectively, of Company X’s Common Stock. Investor Y has purchased 2,000,000 Shares of Company X’s Series A Preferred Stock, and Company X has established an Option Pool of 1,000,000 Shares. Employee 1 has received an Option Grant of 200,000 Options to purchase Shares of Common Stock. The following table depicts the capitalization of Company X on an outstanding and fully-diluted basis:
|Name||Common Stock||Series A Preferred Stock||Options||Outstanding Shares||Outstanding %||Fully-Diluted Shares||Fully-Diluted %|
|Option Pool Remaining||-||-||800,000||-||0.00%||800,000||8.00%|
Full Ratchet Anti-Dilution: This provision adjusts the number of Shares of Common Stock into which Shares of Preferred Stock convert in the event of a Down Round Financing or other Stock Dilution by reducing the conversion price of the convertible security to the price paid for the dilutive issuance, regardless of how many Shares were involved in the dilutive issuance. This type of anti-dilution is considered very favorable to Investors relative to Broad-Based Weighted-Average Anti-Dilution. For example, if Shares of Preferred Stock were previously sold at $1.00 per Share, and the new Shares of Preferred Stock are sold at $0.50 per Share, Full Ratchet Anti-Dilution would cause each Share of Preferred Stock that was previously convertible into one Share of Common Stock to now be convertible into two Shares of Common Stock.
Going Public: When a Private Company offers Shares to the public in an Initial Public Offering or a Direct Listing.
Grant: An award from the company to an individual for a number of Shares or an Option to purchase a number of Shares. Grants are approved by the Board of Directors under a Stock Option Plan.
Growth Equity: Growth Equity sits at the intersection of Private Equity and Venture Capital. It is usually characterized as a minority investment in later stage companies that need capital to scale operations.
Holding Period: The period of time a Stockholder must hold his or her Stock in a company for a specified reason. For example, the tax Holding Period determines whether a sale of Securities will receive short-term or long-term Capital Gain treatment. A Holding Period can also refer to the Vesting Holding Period, or the Holding Period under securities laws that require Shares to be held for a certain period of time before reselling without registration under the Securities Act.
Options are considered “In the Money” when the current valuation of the Stock is greater than the Exercise Price.
Incentive Stock Option (ISO): A type of Option that can only be granted to company Employees under a written plan that meets certain qualifications. ISOs qualify for beneficial tax treatment under the Internal Revenue Code. An ISO is generally not taxed upon Grant, Vesting or Exercise, but instead is taxed when the recipient disposes of the Shares acquired upon Exercise of the ISO as Capital Gain (short- or long-term, depending upon the Holding Period of the Shares).
Income Statement: A statement which reports a company’s Net Income, which is total Revenue and gains minus total expenses and losses.
Incorporation: A company is considered to exist when its Certificate of Incorporation has been filed with the secretary of state. This is referred to as Incorporation or formation.
Indemnification Agreement: An agreement which may be entered into by Directors and Officers of the company. The agreement generally provides for the company to indemnify (and advance expenses to) the Director or Officer for actions taken by the Director or Officer in connection with their service to the company.
Independent Contractor: A consultant who works for the company but is not an Employee. What is the difference between independent contractors/consultants and Employees?
Independent Director: A Director who has knowledge and important contacts in the industry but who is not an Investor, Founder or Employee of the company.
Information Rights: The right to receive the company’s Financial Statements and to inspect the books and records of the company. These rights are often given to Preferred Stockholders.
Initial Public Offering (IPO): The first sale of Securities to the public by underwritten registration under the Securities Act of 1933, as amended. The Securities offered in an IPO are typically Shares of Common Stock of the company.
Institutional Investor: Entities that are organized with the purpose of investing in various companies. For example, Venture Capital funds are Institutional Investors.
Intellectual Property (IP): Intangible property that is valuable for its intellectual worth. Examples are Copyrights, patents, Trade Secrets, service marks and trademarks.
Intellectual Property Assignment: The transfer of Intellectual Property ownership rights to another party.
Interest Rate: The Interest Rate is the amount charged by the lender for use of assets (usually cash), expressed as a percentage of the borrowed amount (also called the principal).
Internal Revenue Code: Title 26 of the U.S. Code, which is the domestic portion of the United States federal statutory tax law.
Investor: A person or entity who invests in a company in exchange for Equity or a convertible note.
Investors’ Rights Agreement: An agreement by and among a company and Investors, typically in a Venture Capital Financing, giving the Investors certain rights, such as Registration Rights, Information Rights and rights of first refusal as to future issuances of capital Stock by the company.
Issued Shares: Shares of the company that have been sold and are currently held by the company’s Stockholders. The number of Issued Shares should never be more than the number of Authorized Shares.
Issuer: The Seller of Securities.
Lead Investor: The Investor who leads the negotiating of the Transaction Documents in a Financing on behalf of all Investors. Lead Investor is not a legal title.
Licensing Agreement: An Intellectual Property Licensing Agreement is an agreement between the owner of the Intellectual Property rights, called the licensor, and someone who is authorized to use the rights, called the licensee, in exchange for a fee or royalty. Licensing Intellectual Property to and from Third Parties
Limited Liability Company (LLC): A type of company that combines the tax advantages of a partnership (i.e., no double taxation) with attributes of a Corporation, including limited personal liability of its owners. The owners of a Limited Liability Company are called Members.
Limited Liability Company Agreement: The agreement entered into by the Members of an LLC that governs the internal affairs and management of the LLC. These rules include procedures for manager and Member meetings, quorum requirements, action by written, manager powers, manager election and voting, creation of committees, officer roles, officer election and term, issuing membership interests or units, restrictions on transfer, indemnification, notice of electronic transmission, voting regulations and day-to-day guidance. The Limited Liability Company Agreement may also be referred to as the “LLC Agreement,” the “Operating Agreement” or the “Company Agreement.”
Liquidation Preference: The amount paid to holders of Shares of Preferred Stock prior to a payment to holders of Common Stock (or more junior series of Preferred Stock) when the company is sold or liquidated. Preferred Stock Key Terms
Liquidity: The ability of an Investor to sell Stock and receive liquid assets such as cash or Public Company Stock.
Lock-up Agreement: An agreement entered into by a Stockholder with the company’s Underwriters providing that the Stockholder is not permitted to sell its Shares for a period of time following a Public Offering of a company’s Securities. The lock-up period is typically 180 days for an IPO and shorter for subsequent Equity offerings. The purpose of the Lock-up Agreement is to relieve pressure on the Stock price following the Public Offering by controlling the supply of Shares that are traded in the market. See also Market Standoff Agreement.
Employees that are typically executives of the company. The Management Team is in charge of carrying out the day-to-day operations of the company.
Managers: A person or entity that manages an LLC, similar to a Director with respect to a Corporation. An LLC may elect to have multiple Managers, who function as a board of Managers, similar to a Board of Directors at a Corporation. Alternatively, the Members of a Limited Liability Company may elect to be member-managed, in which case the LLC will not have any Managers. Managers may or may not have Fiduciary Duties to an LLC or its Members.
Market Capitalization: The value of a company that is traded on the Stock market, calculated by multiplying the total number of Shares by the present Share price. Market Capitalization is a common term used to describe the value of a Public Company.
Market Standoff Agreement: This provision is an agreement between a Stockholder and the company, and is similar to a Lock-up Agreement, restricting a Stockholder from selling its Shares for a period of time following a Public Offering of a company’s Securities.
Members: The Members of a Limited Liability Company are its owners.
Merger: When a business entity, typically a Corporation or an LLC, is combined by operation of law with one or more other business entities. In a Merger, one entity is merged into another entity, with one of the two entities being the legally surviving entity.
Minutes: Minutes of a meeting of the Board of Directors is a summary of attendees and topics addressed during the Board Meeting. Board Minutes include specific resolutions presented to and approved by the Board of Directors. Minutes also typically include a high-level summary of matters discussed during the meeting and are signed by the meeting’s secretary.
Venture Capital and Startup community. The NVCA advocates for public policy that supports this community and provides model documents for financing Transaction Documents, which reflect current practices and customs.
Net Income: A company’s income minus costs of goods sold, expenses, depreciation and amortization, interest and taxes.
Non-Accredited Investor: Any Investor who does not meet the requirements of an Accredited Investor. What is an Accredited Investor?
Non-Compete Agreement: An agreement that restricts a Service Provider of a company from competing against the company for a specified period of time.
Non-Disclosure Agreement (NDA): Another name for a Confidentiality Agreement.
Non-Solicitation Agreement: An agreement that restricts a Service Provider of the company from recruiting or soliciting certain Employees, customers or clients of the company for a specified period of time.
Nonqualified Stock Option (NSO): A type of Stock Option typically granted to non-employee Service Providers. An NSO does not qualify for the beneficial tax treatment allowed for ISOs.
Offer Letter: A letter which generally sets forth the terms and conditions of employment, such as base salary, bonus eligibility, Equity compensation eligibility (and sometimes required minimum grants or target amounts) and health and welfare benefits. It can also include provisions with respect to termination of employment.
Officers: Employees that are elected by the Board of Directors and manage the day-to-day operation of the business. The titles and roles of the company’s Officers are detailed in the Bylaws, including whether an Officer has the authority to bind the company by signing certain contracts without additional approval of the Board of Directors.
Option: An Option gives the holder of the Option the right to purchase a certain number of Shares at a specified price (the Exercise Price). Options are typically granted pursuant to a Stock Option Plan. Service Providers who are granted Stock Options can profit by Exercising their Options to buy Shares and selling those Shares at a price that is higher than the Exercise Price, usually in an Exit. What is a stock option plan?
Option Grant: An Option Grant occurs when an Option is approved by the Board of Directors, and the Option Grant documents are signed by the company and the grantee.
Option Pool: The number of Shares set aside and reserved for issuance under a Stock Option Plan. Options cannot be validly granted under such a plan unless there are enough Shares set aside in the Option Pool to cover them. The size of the Option Pool can be increased by amending the Stock Option Plan with the approval of the company’s Board of Directors and, if the Stock Option Plan provides for the issuance of Incentive Stock Options, the Stockholders.
Organizational Documents: The Organizational Documents of a Corporation are the Certificate of Incorporation and Bylaws, and the Organizational Documents of a Limited Liability Company are the certificate of formation and the Limited Liability Company Agreement.
Outstanding Shares: The Shares of a company that are Issued and outstanding, and do not include Shares issuable in the future pursuant to Options, Warrants, convertible notes, SAFEs or other convertible securities.
Par Value: A legal concept describing the minimum value of the company’s capital Stock set forth in its Certificate of Incorporation. The Par Value of capital Stock has no bearing on the actual Fair Market Value of the capital Stock.
Participating Preferred Stock: Preferred Stock that receives both its Liquidation Preference and its pro rata Share of any assets distributed to holders of Common Stock. Participating Preferred Stock is an Investor-friendly Liquidation Preference.
Pass-Through Entity: For tax purposes, a Pass-Through Entity’s income is generally taxed only one time at the Stockholder level. Partnerships (including limited liability companies that elect to be taxed as partnerships) and subchapter S Corporations are all examples of pass-through entities.
Piggyback Rights: A type of Registration Right. Piggyback Rights give the Investors the right to register their Shares when the company or another Investor initiates a registration.
Post-Money Valuation: The value of the company after a given round of Financing and is calculated as the Pre-Money Valuation plus the amount invested in the Financing. The Post-Money Valuation can also be calculated as the per Share price paid in the most recent Financing multiplied by the Fully Diluted Capitalization following the Financing. For example, if the company and Investor agree that the company’s Pre-Money Valuation is $8 million and the Investor will invest $2 million, then the company’s Post-Money Valuation is $10 million.
Preemptive Rights: Rights of existing Stockholders to purchase their pro rata portion of new Securities to be issued by the company.
Preferred Stock: Stock usually issued in venture Financings which has special rights that are Senior to the rights of Common Stock, both with respect to economic rights (the right to get paid back first) and control rights (the ability to appoint Directors and consent requirements for certain transactions). Convertible Preferred Stock is convertible into Shares of Common Stock.
Preferred Stockholder: A holder of the company’s Preferred Stock.
Preferred Stock Purchase Agreement: The agreement by which an Investor purchases and the company issues Shares of Preferred Stock in a Financing round. The agreement includes a schedule of Investors, Representations and Warranties, and closing conditions.
Pre-Money Valuation: The value of the company before a given round of Financing. Preferred Stock Key Terms
Private Company: A company whose Stock does not trade in public markets. Startup companies are private until they go public in an Initial Public Offering or Direct Listing.
Private Equity Fund: A fund that typically buys a controlling stake in mature companies to make improvements before an Exit. This is in contrast to Venture Capital firms, which usually buy a minority stake in Startups that have the potential of high growth.
Profit: The money left over once all expenses have been subtracted from all Revenue.
Proprietary Information and Inventions Assignment Agreement (PIIA): An agreement ensuring that the company, rather than the Employee or Service Provider, owns the technology and Intellectual Property that the Employees develop.
Protective Provisions: A list of company actions that require the separate approval of the Preferred Stockholders as a class, or as a specific series of Preferred Stockholders for the company. Preferred Stock Key Terms
Public Benefit Corporation (PBC): A for-profit Corporation intended to produce a public benefit (which must be specified in the company’s charter), and whose management is obligated to act in a responsible and sustainable manner, rather than solely in the best interests of the Stockholders.
Public Company: A company with Shares registered under the Securities Exchange Act of 1934 that are traded in the public markets, including national securities exchanges.
Public Offering: A sale of Securities, generally Shares of Common Stock, to the public by registration under the Securities Act. This can be in an Initial Public Offering or it can be when a company returns to the market to offer another round of Stock.
Shares of a qualified small business as defined by the Internal Revenue Code (U.S. Code Section 1202) that provide some tax benefits for Founders of and Investors in early-stage companies, if both the Investor and the company meet certain requirements.
Quality of Earnings Report: A report typically used in Due Diligence that provides a detailed analysis of the company’s financial condition and economic earning power. These reports are typically prepared by independent third-party accounting firms. Prepare for Financial and Accounting Diligence, Including a Quality of Earning (Q of E) Review
Quorum: The minimum number of voting members that must be present at a meeting in order for the proceedings of the meeting to be valid. The Quorum for meetings of the Board of Directors and for meetings of the Stockholders are set forth in the company’s Bylaws.
Registration Rights: Registration Rights allow Investors to require the company to list Shares publicly so the Investors can sell their Shares. The different types of Registration Rights include Demand Registration Rights, Piggyback Registration Rights and S-3 Registration Rights. Preferred Stock Key Terms
Representations and Warranties: Representations and Warranties are included in contracts, including merger and acquisition agreements, note purchase agreements, stock purchase agreements and asset purchase agreements. One party in the contract represents and warrants to the other party that something is true as of a specific date or dates, and if it is not true, an appropriate disclosure will be provided in Disclosure Schedules that are attached to the agreement.
Restricted Stock: Stock that is subject to Vesting. If the Stockholder ceases providing services to the company, the company has the right to repurchase (or terminate) any of the Shares that were not then vested (typically at early stage companies where Employees pay a purchase price to receive Restricted Stock), by paying the Employee Stockholder back the original purchase price paid for the Shares. For tax reasons, at early stage companies, Restricted Stock is generally only used for grants to Founders, when the company is formed, and to the earliest Employees who are with the company at or near formation.
Restricted Stock Purchase Agreement: The agreement by which the Founders receive Shares of Stock. It contains provisions relating to Vesting and other customary restrictions on the Shares.
Retained Earnings: The amount of Net Income retained by a company. Companies can pay Stockholders Dividends from Retained Earnings, but Startups typically do not do this. Instead, Startups usually invest any cash back into the company.
Revenue: A company’s income from its normal business activities.
Right of First Refusal: A contractual right, often used in Venture Capital Financings, which gives the company that issued the Shares and/or the Investors the right to purchase Shares held by Founders or management Stockholders before the Shares are sold to a third party.
Right of First Refusal & Co-Sale Agreement: One of the Transaction Documents of a Preferred Stock Financing, which sets out Rights of First Refusal and Co-Sale Rights held by the company and the Investors.
Runway: How many months a company can continue operating until it runs out of money and needs to raise additional funds.
S-3 Registration Rights: A type of Registration Right. S-3 Registration Rights give the Investors the right to force the company to register Shares on a Form S-3, which is a form of registration statement that may be used by public companies that meet the eligibility requirements to register Shares for sale to the public. The Form S-3 is shorter than a Form S-1, the registration statement that is used to register Shares in an IPO.
S Corporation: Corporations that elect to be taxed as “pass through entities,” meaning that they elect for their income to be taxed only one time at the Stockholder level. To qualify as an S Corporation, the company must (i) be a domestic Corporation, (ii) have 100 or fewer Stockholders, (iii) have only one class of Stock, (iv) have only allowable Stockholders, which includes individuals and certain trusts and estates, but does not include partnerships, Corporations or non-resident aliens, and (v) must not be an ineligible corporation (i.e. certain financial institutions, insurance companies and domestic international sales corporations).
Securities: Negotiable financial instruments that represent value, such as Equity or debt.
Securities and Exchange Commission (SEC): An independent federal regulatory agency founded in 1934. The SEC is responsible for protecting Investors, preserving fair and orderly functioning of the Securities markets and facilitating capital formation.
Seed Financing: A round of funding in an early stage company prior to a Series A Financing. This is the first stage of funding, meant to help the company pursue its business plan and allow it to grow into a successful enterprise.
Seller: The company acquired in a transaction, or the party selling assets in an asset sale.
Senior: Senior can refer to Senior debt or Senior Securities. In the event of an Acquisition, liquidation or termination of a company, Senior debt would be paid back before subordinated debt, and Senior Securities would be paid out before junior Securities.
Series A Financing: One of the stages of raising capital by a Startup. A Series A round comes after a Series Seed round and before a Series B round. It is usually the first round of Financing lead by a Venture Capitalist or other Institutional Investors.
Service Provider: Either an Employee of the company or an Independent Contractor, or a consultant of the company.
Shares: A unit of the company’s Equity.
Startup: A new business. Typically, a Startup is small in the beginning but hopes to have significant growth over time.
Statement of Cash Flows: A Financial Statement that summarizes the amount of cash and cash equivalents entering and leaving the company. A Statement of Cash Flows shows how well a company generates and manages its cash.
Stock: Stock or capital stock represent Equity ownership in a company.
Stock Certificate: The instrument that represents the Stock, a Stockholder owns in the company. Stock Certificates used to only be in the form of paper that had to be kept safe from theft or loss. However, today they can be issued and stored online.
Stock Ledger: A company’s Stock Ledger is similar to a Capitalization Table in that its purpose is to keep an accurate record of all transactions involving the company’s Stock. A Stock Ledger, like a Cap Table, provides a snapshot of each Stockholder’s current holdings, but also provides a historical record of each transaction involving the company’s Stock. The Stock Ledger also keeps track of certain other details, including the certificate number for each Stock Certificate ever issued, so that every Stockholder's ownership of Stock can be retraced, and the company can replace lost or damaged Stock Certificates. What is a capitalization table and what information does it typically include?
Stock Options: See Option.
Stock Option Plan: A written document established and maintained by a company that authorizes the company to grant Stock Options to Employees and other Service Providers. Stock Options may also be authorized under a broader Equity Incentive Plan that authorizes the company to grant different forms of Equity, including Stock Options and Restricted Stock, to Employees and other Service Providers.
Stockholder: A holder of the company’s Common Stock or Preferred Stock.
Strategic Investor: An Investor that is an operating company that invests in a company for a specific reason and is typically in the same or related industry as the company it is investing in. A Strategic Investor is different from a Venture Capital fund, Private Equity Fund or other Institutional Investor.
Target Company: The company purchased in an Acquisition.
Term Sheet: A non-binding summary document agreed upon among the company and the proposed Investors that describes the most important aspects of the proposed Financing. Venture Financing Process: What is a Term Sheet?
Trade Secret: A device, formula, process or technique that is an important component of the business. A Trade Secret has value from not being known to the public, and a company usually takes substantial efforts to maintain its secrecy.
Tranche: In Financings, a Tranche is often used to describe each closing in a Financing that is designed to have multiple investments, often tied to achieving agreed-upon milestones. For example, if a Series A Financing has two closings (an initial closing and a second closing), then the Financing has two Tranches. This may also be referred to as a “Tranched Financing.”
Transaction Documents: The principal documents for a specific transaction. The Transaction Documents in a Preferred Stock Financing are typically a Stock Purchase Agreement, Amended and Restated Certificate of Incorporation, Investors’ Rights Agreement (IRA), Right of First Refusal & Co-Sale Agreement (ROFR) and Voting Agreement.
Transfer Restriction: Transfer Restrictions limit the ability of a Stockholder to transfer his or her Shares in the company. Transfer Restrictions can be set forth by statute, a company’s Organizational Documents, or provisions in the grant documents. In Startups, most Common Stock is subject to a Right of First Refusal.
Underwriter: An investment bank that buys Securities from the Issuer and then resells these Securities in a Public Offering.
Underwriting Agreement: The contract in which Underwriters agree to purchase Securities from an Issuer.
Up Round: A round of Financing in which the Valuation of a company increased since its last Valuation.
Valuation: Valuations of companies by Venture Capital Investors are highly subjective and are typically based on an analysis of the potential opportunity and associated risks. Valuations are recalculated at each Financing round, and can fluctuate based upon the company’s performance, changes in its target market and changes in the public Stock market, among other things. See Pre-Money Valuation and Post-Money Valuation.
Venture Capital: A form of Financing provided to Startup companies that are believed to have the potential for growth. The risk capital can be in the form of Equity or debt.
Venture Capitalist: An investment firm or person that provides funding to early stage companies in return for an Equity interest or debt.
Venture Debt: A debt Financing structure for early and growth-stage companies. It is typically structured as a fixed-rate loan that is paid back over time and is provided by lenders to venture-backed companies that lack the usual assets and cash required for traditional bank debt Financing. Usually, Venture Debt is Senior to other company debt and does not include the typical financial Covenants, such as maintaining a specific debt to total assets ratio. However, the Interest Rates on Venture Debt are typically higher than Interest Rates on traditional bank loans. Additionally, a venture lender typically receives a Warrant to purchase company Stock.
Vesting: Vesting denotes an encumbrance on Shares for a period of time, subject to service to the company or achievement of some other milestone. The rights to Exercise the Option or the ability to hold the Restricted Stock free from the risk of forfeiture and/or repurchase provisions are released to the holder in a staggered manner, becoming exercisable or held clear of restrictions at certain points over a specified time frame or upon the occurrence of specified milestones.
Vesting Commencement Date: The date the Vesting Period begins, which, in a Startup, is often but not always the date a person begins working for a company.
Vesting Period: The Vesting Period refers to the overall period of time Restricted Stock or an Option, will be subject to Vesting, as measured from the Vesting Commencement Date.
Vesting Schedule: The Vesting Schedule refers both to the Vesting Period and how the Vesting Tranches will be measured—e.g., monthly, quarterly or annually. If Stock is subject to a four-year Vesting Schedule, the last Tranche of Stock, subject to Vesting, will vest on the fourth anniversary of the Vesting Commencement Date. Some Vesting Schedules may also include Cliff Vesting.
Voting Agreement: One of the Transaction Documents in a Preferred Stock Financing, which sets out the rights of various parties to designate Directors to the Board of Directors. The Voting Agreement may also include Drag-Along Rights.
Voting Rights: A Stockholder’s right to vote on certain matters related to the company, such as the election of Directors.
Warrant: A contractual right, exercisable over a specified period of time, to acquire a stated number of a company's Securities (typically, Common Stock) at a specified price—known as the Warrant Exercise Price or "strike" price.
Waterfall: The order of payment of proceeds, by which lenders receive payments from a company first, followed by Preferred Stockholders, with Common Stockholders receiving payments last. Waterfall payments can occur in different transactions, such as in bankruptcy or in a Merger.
Written Consent: A signed writing by the company’s Board of Directors or Stockholders that approves specific actions in lieu of voting at a special or annual meeting.