The Startup Encyclopedia

An angel group is a professional organization made up of individual angel investors who work together to identify and evaluate investment opportunities. When said opportunity is identified, they pull from the pooled funds to write a single check to the business.

The benefit of receiving funding from an angel group is that they typically have shared knowledge in the space and connections with industry operators. They also typically have connections to advisors and later stage investors, to whom they will likely introduce you.

Unlike an angel group, an angel syndicate is an informal group of accredited investors who can select to opt-in or out of individual investment opportunities. Each opportunity requires investors to write a new check, with which they pool together to invest (similar to crowdfunding).

The benefit from receiving funding from an angel syndicate, is that they typically are made up of individual operators who invest on the side vs a group of professional investors. Depending on your business model, these operators may introduce you to your first customers.

Annual recurring revenue, is a dollar figure that represents the normalized annual revenue that a company generates for providing a product or service. Used to determine the predictability of a businesses’ annual revenue, is typically applicable for companies that have a subscription component to their revenue model. Investors use a company’s ARR to quantify its growth, evaluate the success of the business model, forecast future revenues and provide revenue based financing.

Anti-dilution protection (also know as an anti-dilution clause, subscription right, subscription privilege, or preemptive right) is used by investors to protect their investment in the event of a down round, or a significant dilution event, such as the issuance of new shares for a round of equity financing, or the conversion of a convertible note. It is triggered when the strike price for a round is less than the strike price from the prior round. The two commonly known types of anti-dilution protection include: "full ratchet" and “partial ratchet/weighted average.”

“Asset Lite” refers to the amount of assets on a business's balance sheet. A business that is considered “asset lite” has little to no depreciating assets on their balance sheet. Businesses with an asset-lite business model typically delivers a better return on assets, lower profit volatility, and greater flexibility, compared to asset-heavy models. Examples of asset-lite businesses include: Airbnb, Uber, Lyft, Doordash, Instacart, and Postmastes.

Bargaining power refers to the relative ability of both parties in a negotiation to influence one another. In most negotiations, there is an inequality between the level of influence that both parties can exert, resulting in a one-sided compromise. However, in some cases, both parties have the same level of influence and thus they have equal bargaining power, resulting in a true compromise.

A bridge loan is a type of short-term loan that is typically taken out for a period of 6 to 12 month for the purpose of “holding-over” a company until they can secure longer-term financing or they can receive significant cash inflows from a signed deal. Bridge loans do not come with extensions, so they are not preferred during periods of economic contraction.

A more founder-friendly alternative to a bridge loan, is revenue based financing, which enables a company to convert their future revenues into upfront capital.

Bullet loans, also referred to as balloon payment loans, come with lower monthly payments, a higher interest rate, and a required lump sum payment at the end of the loan's term. Sometimes, the monthly payment is interest only and does not apply towards the principal, resulting in the entire principal of the loan plus interest being due at the end of the loan term.

Bullet loans are most frequently utilized when a business expects to receive a large inflow of cash at some point in the near future, but they need cash today to continue operations. So they take out a bullet loan with a term that best fits their needs, and they pay it back when they receive said inflow.

While bullet loans can be useful for some circumstances, a more founder-friendly alternative is revenue based financing, which enables a company to convert their future revenues into upfront capital.

A company’s burn rate refers to the sum of its cash outflows and its cash inflows each month. During periods of economic expansion, a venture-backed startup’s burn rate is typically much higher than it is during periods of economic contraction. A company’s burn rate is used in conjunction with its growth rate to calculate its runway, here’s a helpful tool to calculate your runway.

A contingent liability provides coverage for losses to a third party for which the insured is vicariously liable. There are three types of contingent liabilities: 

1. Probable - can be reasonably estimated to occur (and must be reflected within financial statements).
2. Possible - are as likely to occur as they are to not occur (and need only be disclosed in the financial statement footnotes)
3. Remote - are extremely unlikely to occur (and do not need to be included in financial statements at all).

A convertible note is a debt vehicle used by early-stage investors to invest in a startup that doesn’t have a valuation—it starts as debt and transforms into equity upon certain milestones being achieved. The four main terms of a convertible note include its: interest rate, discount rate, maturity date, and valuation cap.

The cost of capital refers to the expenses related to a company’s raised funding. For revenue based financing the cost of capital is straightforward, it’s a fixed dollar amount. For convertible debt vehicles, such as SAFEs or convertible notes and equity financing, the total cost of capital is much less straightforward, because it depends on the ultimate exit valuation of the business and the provisions contained in the agreement.

Dirty term sheets, also known as predatory term sheets, are used to describe term sheets that are riddled with one-sided provisions and terms that are not in the founders’ favor. They are often deployed when a startup wants to raise capital while maintaining its inflated valuation and are based on internal rate of return mechanics other than price such as—price in kind dividends, or guaranteed multiple hurdles. Dirty term sheets misalign the interests of investors and operators, as investors focus their efforts solely on pushing the startup to go public. AVOID dirty term sheets at all costs.

The discount rate refers to the percentage used to discount a company’s future cash flow to its equivalent present value. The typical discount rate for SaaS startups is 20%, but it can be upwards of 40% in certain situations.

A down round occurs when a startup raises a new round of funding at a lower valuation than a previous round. When this occurs, typically the investors invoke their full (or partial) ratchet rights to ensure that they are not diluted.

The term ‘drag along rights’ refers to the ability of majority shareholders to force minority shareholders to join in the sale of a company at the same price, terms, and conditions as they received. If applicable, the drag along rights will be detailed in the provisions of the term sheet.

The term ‘duty of care’ refers to the responsibility of the directors and officers of a company to conduct a reasonable amount of diligence prior to making a decision in good faith that aligns with the best interests of the company. The decision they make must also align with the decision that a prudent person would reasonably be expected to take in a similar position and under similar circumstances.

The term ‘duty of loyalty’ refers to the responsibility of all directors and officers of a company to act at all times in the best interest of the company, without personal conflicts of interest. One such example is the requirement to keep all company information confidential, and to not misuse or disclose such information.

Equity dilution is a decrease in the ownership percentage of a company held by individual shareholders, resulting from the issuance of new equity. This can happen when a startup fundraises or raises capital by issuing additional shares of stock.

The term ‘equity financing’ refers to a funding arrangement where an investor provides capital to a startup in exchange for equity or stock in the company. Venture capitalists, angel investors, angel syndicates, private equity groups and more all invest in companies via equity financing.

Founders shares, also known as founders equity or founder stock, refers to the equity that is allocated to the founders of an organization. In reality, there is no legal difference between founder's stock and common stock, other than the “founder’s stock” may come with additional restrictions, voting rights, and other rights.

As the name implies, in the friends and family round, your friends and family provide a capital injection into the business. It’s typically the first informal round of capital put into the business, preceding the pre-seed funding round.

The term ‘fully diluted shares’ refer to the total number of common shares of a company that are outstanding and available to trade after all possible sources of conversion, such as convertible bonds and employee stock options, are exercised.

A funding round includes any formal cash injection into a business by an investment fund or accredited investor. Funding rounds for most startups typically range from pre-seed to series e, but hypothetically can go on forever.

The gross margin of a product or service is a percentage that is calculated by subtracting the cost of goods sold from revenue, then dividing said figure by the revenue. The gross margin for software businesses is typically much higher than businesses that sell products.

Growth capital is injected into businesses at critical points in their lifecycle, enabling them to acquire more customers and hire more team members—ultimately resulting in an accelerated period of growth. Growth capital comes in many forms, but the most common include: venture capital, venture debt and revenue based financing.

Startups reach the growth stage when they have acquired a fair amount of customers, generate a steady source of income, and have proven product-market fit.

Information rights is a provision in a term sheet that outlines the information a company must provide its investors beyond what state law requires.

Examples of information rights provided to preferred shareholders in private companies include
financial statements, capitalization table, budget, and inspection rights. 

Liquidation waterfall defines the payout order in the event of corporate liquidation. Typically, the companys' preferred stockholders get their money back first, ahead of other kinds of stockholders (common shareholders) or debt-holders. These liquidation preferences can include a mix of standard and non-standard terms that further affect the payout order.

The term ‘merchant cash advance’ refers to the purchase of a company’s receivables—the company receives a lump sum payment in exchange for making fixed monthly payments in the future.

Merchant cash advances are a form of receivables financing, and revenue based financing. They are the most founder-friendly way for startups to fuel their growth, as there is no debt or dilution. With merchant cash advances, startups can convert their future revenues into upfront capital so they can scale faster, on their terms and without restriction.

The term ‘mezzanine financing’ refers to a hybrid form of debt and equity financing, similar to a SAFE or convertible note, except that it gives the lender the right to convert its debt position into an equity interest in the company in the event of default. Startups leverage mezzanine financing to fund growth projects and to help with acquisitions. Mezzanine financing is subordinate to senior debt, and superior to both preferred and common stock.

The Most Favored Nation Clause gives early investors the same rights and benefits received by later investors, if those rights and benefits are more favorable than those originally agreed to. MFN clauses are typically included in SAFEs and Convertible notes. MFN clauses give investors peace of mind—they are assured that they will not be disadvantaged compared to other investors in subsequent rounds, thus maximizing their potential returns.

Negative cash flow occurs when a business has more outgoing money than incoming money. New companies and startups are typically cash flow negative, while creditors and financiers are willing to overlook this in the early stages of a company’s life cycle – eventually, these companies need to move towards being cash flow positive to receive additional funding.

Non-dilutive funding is a financing tool businesses can deploy to fund their operations. Non-dilutive funding differs from dilutive financing options in that the business is not giving up equity (diluting their ownership) in exchange for funding.

Pros:

• No equity dilution -  Because companies aren’t giving up an ownership stake in exchange for capital, debt financing helps founders maintain control over their business. 
• Cheaper - While debt funding has to be paid back, the overall cost is far less than equity financing as future profits are all yours.
• Leverage - While debt financing requires revenue, it allows you to convert current and future revenue to leverage larger amounts of capital to power your  growth.

Cons:

• Debt is senior to equity in the capital structure which means debt lenders have priority in claims in the event of a bankruptcy. 
• Harder to qualify for - Because debt lenders aim to minimize risk, qualifying for debt financing can be harder than equity financing.
• Liability - Some lenders require a personal guarantee as a backup which could mean founders are personally liable for repayment in the event of business failure. 
• Warrants/Covenants - Some lenders include covenants(conditions) that have to be maintained as part of their funding requirement. Common covenants include the right to purchasing equity or pre-determined debt-to-equity ratios. 
   

The term ‘post-money valuation’ refers to the worth of a company after it has completed a round of funding. The post-money valuation of a company is calculated by dividing the investment amount received by the equity (percentage) purchased by the investor. The post money valuation of a business is always higher than the pre-money valuation of a business. 

The term ‘pre-money valuation’ refers to the value of a company prior to completing a round of funding. It gives investors an idea of the current value of the business and provides the value of each issued share. It is calculated by subtracting the investment amount from the post-money valuation. The pre-money valuation of a business is always lower than the post-money valuation.

Pre seed funding typically follows friends and family rounds. It refers to the initial round of "professional" equity capital into a business. Companies raising pre-seed funding sometimes do not have a product, or even have a prototype—sometimes all they have is an idea. While the amount of capital raised from this form of fundraising can vary, it's typically between $100-$500k.

The term ‘pro-rata rights’ refers to a contractual provision that enables investors to maintain their equity stake and their voting power even when new shares are issued, without the obligation to invest in later rounds. It is typically given to early stage investors who are willing to start up at one of their riskiest points in time. If the investor declines their pro-rata rights and fails to invest in follow-on rounds, they will be diluted. Being able to maintain a consistent ownership percentage in a company can mean the difference between making thousands and millions of dollars for an investor, hence the importance to maintain and activate their pro-rata rights.

Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.

Protective provisions ‘protect’ an investor's rights such as their ability to veto a decision or action that they do not agree with—e.g. the issuance of more stock, the liquidation of the company, or the acquisition of the company. Protective provisions mitigate risk for investors and help protect the interests of minority shareholders in the event that there is a disagreement regarding the best course of action for the company.

Before you sign a term sheet it is imperative that you understand the protective provisions that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.

The term ‘partial ratchet’, also known as a ‘weighted ratchet’ refers to the contractual provision that prevents the dilution of an early investor by future rounds of fundraising, and comes in two varieties: the narrow-based weighted average, and the broad-based weighted average. In either case, it takes into account the number of shares that are issued in the next dilutive financing round and the price is adjusted accordingly. The weighted/partial ratchet is a compromise to ensure that the early-stage investors maintain their benefits for getting in early, while simultaneously being a bit more friendly to the founders of the business.

Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council.

Receivables factoring, also known as accounts receivable factoring, is a type of alternative financing in which a company sells its receivables (invoices) to a third party at a discount to raise capital. It's similar to receivables financing, in that businesses can unlock capital today by tapping into their future accounts receivables, however, the key difference lies in the underwriting process and the collateral that is required.

Receivables financing is a form of non-dilutive funding that allows startups to collateralize their future accounts receivables to receive capital today. This type of financing can be used to fund operating expenses, hire new employees, expand into new markets, and much more.

The term ‘recurring revenue’ is related to the revenue model that a company employs for its products or services. When a product or service requires that it continually be paid for (such as a software subscription), it is said to generate recurring revenue for the business. Businesses that typically have a recurring revenue model include software startups and SaaS businesses.

Businesses that have a recurring revenue model are the perfect fit for revenue-based financing.

Redemption rights give investors that hold preferred stock the right to require that a company repurchase their shares after a specified period of time. They are designed to protect investors when a company’s valuation is stagnant, and is no longer an attractive acquisition target or IPO candidate. While rarely included in a term sheet, they can represent a major problem to companies that do not intend to generate positive cash flows for some time and as a result will not be able to pay back the investor in the event they exercise their right.

Before you sign a term sheet it is imperative that you understand the rights that your potential investors expect—do not agree to terms that you do not understand or have not discussed with your council. The last thing you want to have happen is an investor demands that you buy back their shares, and you don’t have enough capital to pay them back, or you have just enough capital to pay them back, but doing so will jeopardize your ongoing operations.

Revenue based financing is the friendliest way for startups to accelerate their growth, extend their runway and make strategic bets. It’s a type of business funding in which a company secures capital by selling rights to their future projected revenue streams at a discount. This is a win-win for both parties, as the startup receiving the capital can eliminate the time gap between customer-go-live and the eventual bump to their top-line revenue, and the financier generates a predictable return.

The two major types of revenue based financing are receivables financing and receivables factoring. The main difference being the sale of individual invoices (factoring) vs a cash advance on future projected revenue streams (financing).

For a more in depth look at revenue based financing, including the qualifications, top providers and frequently asked questions, check out the comprehensive guide we put together.

The term ‘right of first refusal’, also known as a “preemptive right” refers to the ability of an investor to take the first “at bat” in the event of a potential liquidation event, sale of equity or other relevant trigger. For example the right of first refusal related to the sale of equity would give an investor the right to purchase (or pass) on the shares being offered by a shareholder, before anyone else gets the same opportunity. In the event of a liquidation event, it would give the investor the right to purchase (or pass) on the outright sale of the company and its assets. Typically the right of first refusal is included in the provisions of the term sheet that is provided to the business receiving the investment.

The term run rate refers to the financial performance of a company based on its current business fundamentals, and is used to predict its future performance with the assumption that market conditions remain constant. For example, if a company has generated $50 million in revenue each quarter for the past three quarters, the run rate for the following quarter would be estimated at $50 million, and the annual revenue run rate would be estimated at $200 million.

Calculating the run rate of an organization is a more accurate form of forecasting compared to the bottoms-up and top-down forecasting methods. It is particularly useful for estimating the performance of companies or departments that have been operating for less than a year.

While the run rate of a mature business is relatively consistent, for seasonal businesses or businesses whose sales are highly dependent on the economic landscape (such as the travel or luxury clothing industry) it can be highly inaccurate.

A SAFE note is a form of financing used by early-stage startups (typically seed stage) to raise capital from investors. They are short five-page documents with standard, non-negotiable terms (other than the valuation cap). Like options or warrants, they allow investors to buy shares in a future priced round at a discount, however, unlike convertible notes, they are not debt and do not accrue interest.

The Securities and Exchange Commission (SEC) is an independent governing body that oversees the rules and regulations related to the purchase, sale or transfer of securities in the US. The primary goal of the SEC is to enforce laws against market manipulation.

Seed funding is typically the first official round of equity funding into a business (preceded occasionally by a pre-seed round). Seed funding is leveraged by companies to finance their first round of market research and product development, along with the hiring of a couple of key individuals. The typical investors of a seed round include: friends, family, incubators (like YCombinator), and angel groups and angel syndicates. The typical amount of seed funding ranges from $25,000-$2 million (the medium was $1 million in 2020), at a valuation between $3-6 million.

Senior debt, also known as senior notes or senior loans refers to a form of debt financing that is repaid first in the event of bankruptcy, followed by junior or subordinated debt holders or hybrid debt holders (e.g. convertible notes), preferred shareholders, and lastly common shareholders. Senior debt typically requires a lien against a startup's assets or collateral, and a personal guarantee from the founders of said startup to secure the capital.

A startup advisor is a subject-matter expert who provides industry or subject matter guidance and mentoring. They are typically well connected to investors and other industry professionals, to whom they provide warm introductions.

Advisors are usually compensated for their efforts either monetarily or through equity grants—ranging from 0.05% up to 1%. The ideal time to bring on an advisor is when you’re hiring key staff, pursuing strategic partnerships or ramping your sales.

Avoid bringing on an advisor who has:

• No interest in your business or your mission
• Minimal free time because they are overcommitted to other startups
• A conflict of interest (i.e. advises a similar company in your industry)

An incubator is an organization that provides mentorship, early funding, working space, and connections to help entrepreneurs grow their businesses and develop a minimum-viable product. Well-known incubators include Idealab, The Batchery, Upward, SteelBridge Laboratories, and Invenshure.

Sweat equity refers to the exchange of expertise, labor and time, for discounted equity in the business. Founders and early employees often earn sweat equity when bootstrapping their business, due to the lack of available financial resources.

The total addressable market (TAM) refers to the overall revenue opportunity for a company if 100% of the target audience purchased their product or service. It is useful for early-stage startups when forecasting future revenues using the top-down method and for prioritizing specific products, customer segments, and business opportunities. It becomes less useful as an organization matures and gathers hard data around its true market opportunity.

Warrant coverage is an agreement between a company and an investor, where the company issues a warrant to the investor allowing them to acquire shares at a predetermined price. The holder of a warrant coverage has the right, but not obligation to, buy the additional shares of stock. Warrant coverage is typically issued in situations when a higher-than-normal level of risk is present.

There are many reasons why companies offer warrant coverage, the two most significant are to attract more investors and ensure the maximum participation by committed investors.

Working capital is a dollar figure calculated by subtracting a company’s current liabilities, such as accounts payable and debts, from their current assets—such as cash, and accounts receivable. It is used to pay short-term debts, and day-to-day operating expenses.