Similar to investing in the stock market, angel investing has its own language with terms like “cap table,” “dilution,” “drag-along rights,” and “pro-rata rights”. Part of being an effective investor is learning this language so you can communicate with other investors and founders. Ahead, you’ll find everything you need to know about the founder-funder dynamics, valuation, and investment terms and conditions.
Classifications of investors, funds, and financing.
- Startup: A private company in the early stages of development.
- Founder: The creator and therefore owner of a company or organization.
- Accelerator: A workshop that helps to grow your company and introduce you to investors in exchange for equity. Examples include Techstars, ERA, and Y Combinator.
- Incubator: An organization, platform, or team of experienced professionals that help entrepreneurs grow their business during its early stages. Often, incubator programs provide mentoring, guidance, co-working space, and sometimes, funding.
- Venture capital (VC): A type of funding provided to startups and small businesses to help them grow and succeed, typically structured as cash in exchange for a percentage ownership. Venture capital usually comes from high net worth individuals, investment funds, and other financial institutions, such as family offices.
- Private equity: Composed of funds and investors that invest in private companies. Venture capital is a subset of private equity for the earliest stage companies.
- Accredited investor: A classification given to a person or legal entity that fulfills requirements set by the U.S. Securities and Exchange Commission (SEC) in regard to income, net worth, size of assets, and work experience. Accredited investors are permitted to buy and invest in unregistered securities not available to the general public, including real estate syndications, private equity, and hedge funds.
- Non-accredited investor: An investor who does not meet the requirements for income or net worth set by the SEC. They can only make SEC-regulated investments, such as publicly-traded stocks and bonds.
- Investment fund: Typical structure where the general partners (GPs) raise money from limited partners (LPs) and invest on their behalf.
- Family office: A family that invests their own wealth.
- Fund of funds: Where a venture capital fund invests in a portfolio made up of shares of other funds, instead of investing directly into companies, stocks, bonds.
- High net worth individual (HNW): Someone who holds financial assets with a value exceeding $1 million.
- Corporate venture capital: The investment of corporate funds into startup companies with strategic value to the corporation, with the hope that they will earn significant returns as the companies grow. Examples include Dell, Samsung, Mastercard, and Google.
- Crowdfunding platform: Funding a project or venture through small amounts of money from a large amount of non-accredited and accredited investors, usually through the internet. Examples include iFund Women, SeedInvest, and Republic.
- Angel investors: Individuals investing their own capital, experience, and time in early-stage companies. They personally choose their investments, instead of giving their money to a venture capital fund where money is invested on their behalf.
- Friends and family: Typically the first round of financing to get a company kicked off, where funds are raised from the founder’s friends and family, who are likely to be willing to invest on an interest-free basis.
- Revenue-based financing: Unsecured debt financing for product-based businesses typically with more than $1 million in revenue, where investors receive a percentage of the business’ ongoing gross revenues in exchange for money invested. Examples include Clearbanc, Bigfoot Capital, and Earnest Capital.
- General partner (GP): the person or persons who raise and manage venture funds, set and make investment decisions, and help their portfolio companies exit, because they have a fiduciary responsibility to their LPs.
- Limited partner (LP): Typically a high net worth (HNW) individual who invests money in a venture fund, but has no management authority in the company. They are passive investors, with limited liabilities up to the value of their investment.
- Broker-dealer: Firms, banks, or individuals that buy and sell securities (stocks and bonds). Sometimes they act as a broker, helping their clients buy or sell securities; as a dealer, they sell securities for more than they paid.
- SEC: The Securities and Exchange Commission is a large independent agency of the U.S. federal government that was created following the stock market crash in the 1920s to protect investors and the national banking system. It is the main regulatory system in the U.S. securities market, overseeing the capital market, and regulating the buying and selling of stocks and bonds to protect investors against fraud.
Understand investment timelines.
- Early-stage vs. Late-stage: Early-stage investments (pre-seed, seed, and Series A) fund the initial stages of business development, such as helping founders start the business, developing and marketing products, and establishing manufacturing and increasing sales. Late-stage is typically considered Series C and beyond or “Growth Stage” when the company has provedn its success in the market. Late-stage investing goes to companies that have moved past the initial startup phase of development and have a strong market position.
- Pre-seed vs. Seed-stage vs. Series A: When a company is raising a pre-seed round, they are usually pre-product and/ or pre-revenue, meaning they have a product idea and need funding to create that product. Seed-stage is either post-product or post-revenue, but predictable monthly revenue (MRR) isn’t significant. Series A comes after Seed Stage and is typically given to companies who have found product-market fit and are hitting an inflection point in their development.
- Bridge round: When a startup needs to raise money between rounds (for example, between their Seed and Series A rounds), they will raise a bridge round.
- Stock option pool: Shares of stock set aside for employees of a private company. It incentivizes talented employees to work for startups because employees will be compensated with stock if the company goes public (IPO) or is sold.
- Demo Day: Graduation day for accelerators where founders pitch to investors.
- Liquidity event: The moment when investors get their money back, typically through an acquisition or IPO.
- Acquisition: When a corporation purchases all or most of another company’s shares to gain control of the entity, such as Amazon acquiring Whole Foods, or Google acquiring Waze. An acquisition may occur to acquire intellectual property, achieve economies of scale, enter a foreign market, or for various other reasons.
- Initial public offering (IPO): The first time that a private company issues stock to the public, with the primary objective of raising money for growth.
Founder-funder dynamics, valuation, and investment terms and conditions.
- Term sheet: Investors provide founders with a term sheet, summarizing the basic terms and conditions for making an investment. It provides a simple and inexpensive template for lawyers to follow when creating more detailed deal documents between founders and investors.
- Round dynamics: The people or entities who invested in the funding round. A round has strong dynamics when there are strong and notable investors participating.
- Liquidation preference: Guarantees the return of an investor’s capital before any distributions are made to common shareholders, which typically includes the company’s founders and owners. For example, a 2X liquidation preference would mean the investor gets to take out double their original investment prior to common shareholders getting to retract any money.
- Valuation cap: The ceiling on the valuation for convertible notes and SAFEs (debt that converts into equity at a predetermined time). It ensures that an investor doesn’t miss out on appreciation between the time of the sale of convertible notes and qualified financing – they will receive equity at the lower price of A) the valuation cap or B) the pre-money valuation of the next equity round.
- Pre-money vs. Post-money valuation: Pre-money valuation refers to the value of a company before an investment round. Post-money valuation refers to how much the company is worth after receiving investments ie If you raise $1M on a $4M pre-money, the valuation is $5M post-money.
- Discount rate: The discount to the valuation an investor will receive in the subsequent financing round. This rewards investors for bearing the risk of investing early.
- Convertible note: A unique form of debt that became popular in the 2010s that converts into equity at a predetermined time, usually in conjunction with a future financing round. The investor effectively loans money to a startup with the expectation that they will receive equity in the company in the future at a discounted price per share when the company raises its next round of financing.
- SAFE (Simple Agreement for Future Equity): Y Combinator invented the SAFE in 2013 to provide a standardized legal template for founders to reduce required negotiations with investors. However, they lack comprehensive founder and investor protections so some investors won’t touch them.
- Preferred vs. Common equity: Typically, in the US, a company’s founders will hold common equity which includes voting rights. Investors will hold preferred equity which does not include voting rights, limiting an investor’s control over the future of the company. However, preferred shares get preferential treatment in a liquidity event. Common shareholders will not be paid until after debt holders, creditors, and preferred shareholders.
- Priced (or Equity) round: The traditional approach to raising funds where an investor and founder negotiate an exact valuation of the company and how much ownership an investor will receive for making an investment.
- Capitalization (“Cap”) table: A list of founders, investors, and employees and their ownership percentages. It can be used to record who needs to sign off on major company decisions, and who owns common vs. preferred stock.
- Dilution: The reduction in current shareholders’ ownership in a company when it issues new shares of stock.
- Ownership percentage: The percentage representation of each owner’s stake in a company.
- Pro-Rata Rights: An investment agreement that protects against investor dilution – it allows investors the option to maintain their initial equity stake as the company raises more capital by giving investors the right to participate (if they choose) in future funding rounds.
- Non Disclosure Agreement (“NDA”): A contract between two parties that restricts the sharing of information disclosed in the agreement. Companies can use NDAs to protect confidential information, ensure their ideas are not stolen and protect trade secrets. They are more common for strategic or late-stage investors.
Understand sustainable economic earnings and working capital needs.
- MVP (“Minimum Viable Product”): An early version of a product with just enough features to be used by the customer, allowing the customer to provide feedback to the founder. Examples include wireframes, mockups, demo videos, and sketches.
- MRR (“Monthly Recurring Revenue”): A number used for forecasting future revenue calculated by multiplying the number of paying users by the average revenue per user ie you have 10 subscribers paying $1,000 per month so your MRR is $10,000 Note: Revenue must be contractually recurring typically seen in 1+ year contracts like in software sales. One-time purchases such as clothing and beauty products would not be included.
- Burn rate: The rate at which a company spends its supply of cash over time, before generating its own income. It also refers to the amount of time before a company runs out of money. Investors love to see founders who have an accurate understanding of their burn rate.
- P&L: A profit and loss statement that summarizes the revenues and expenses of a company over a given period of time. It is used to track performance on a monthly basis. Investors will typically ask to see historical and forecasted monthly P&L for a 2-5 year time period.
- CapEx (“Capital Expenditures”): A company’s spending on the purchase or repairs of fixed assets, such as building and equipment. Typically, hardware or real estate companies are CapEx intensive whereas software is not.
- Balance Sheet: One of the 3 main financial statements – It is a recording a company’s assets, liabilities, and shareholders’ equity on a single day depicting a snapshot of a particular point in time. Investors typically request the most recent month-end or year-end balance sheet to review.
- Daily Active Users (“DAUs”): The total number of unique users on a given day. This is used to measure the engagement and growth of a product or app.