Legal & Startup Glossary
Type of vesting which takes place faster than the initial chronogram scheduled in stock options agreements concerning founders, workers or third-parties investors. The most usual types are Single Trigger or Double Trigger.
Clause usually inserted in promissory note which allows the note holder (lender) to require the entire amount of the promissory note due immediately. An Acceleration Clause is typically triggered after a startup incurs an “event of default”.
Term which includes a variety of different types of companies and/or facilities whose purpose is to jump start the development of startups. Accelerators will also generally invest small amounts of capital into the startup for a certain percentage (usually pretty small) of equity.
Person or entity whom fulfill some requests described on Rule 509 of Regulation D, issued by SEC.
The buying process of 50% or more of a company stock.
American Depositary Receipts, shares of a foreign company traded on United States.
Group of persons selected by a startup for their experience, network or experience. Some will prefer to join a advisory board rather another official position because of potential liability. The work of these advisors is normally obtained in change of equity.
Amended and Restated Articles of Incorporation
Amended and Restated Articles of Incorporation is the legal document filed with the secretary of state that restates, integrates, and further amends the original articles of incorporation (i.e., the Charter) of the startup. This document is required to be filed in order to establish the rights and preferences of each round of new stock issuance.
Payment in full of a debt or loan over a period of time.
In a Venture Capital definition, an analyst is an employee that does research of potential investments and insert these information on a spreadsheet.
Financing round that a startup receives of one or more angel investor at the early stage of business.
Group of angel investors formed to invest in startups by a structured business.
Person who invests on an early stage company typically before a VC does.
A preferred stock term typically given to venture capital investors that protects the VC investor from a large reduction in ownership of a startup due to the startup’s issuance of new shares or classes of shares at a price per share lower than what the VC investor previously paid.
The amount of anti-dilution will depend on what type of protection is adopted on the investment agreement, which can be: Weighted Average, Broad-based Weighted Average, Narrow-Based Weighted Average, Full Ratchet.
Articles of Incorporation
Legal document that is filed with the secretary of state to create a corporation, that contain corporation’s basic information such as name, address, registered agent, directors, etc. The same as Charter or Certificate of Incorporation.
Metric used to determine the full amount of equity converting preferred shares into non preferred shares.
Term which defines the acquisition of a company assets instead of your equity.
In the VC definition an associate is an employee who does investments research and analysis.
Employee which can have his/her work terminated any time.
The maximum amount of shares authorized for a startup to issue. The number and classes of authorized shares must be have been inserted on Articles of Incorporation.
Clause which provides automatic conversion of debit to the type of equity raised on a Qualify Financing. This conversion is called automatic since it is not necessary the consent of shareholders or investors to take place.
Document issue by a startup to its legal counsel whereby the CEO or President certifies some business facts that the lawyers will need to form a legal opinion. A back-up certificate is not a closing set document.
Document that lists the assets, debts and equity of a company in a certain date.
Situation where a company is not able to pay its debts.
Usually found on loans and interest rates, a basis point is equal to 1/100 of 1% of the total debt.
Amount of loss verified and supported by the buyer on an acquisition agreement before the use of indemnity provisions.
Performance target. When put on an agreement, Benchmark can trigger a financial compensation for a company’s directors or a new round of financing.
Best Efforts Offering
Type of securities offering, where the underwriter only provide his “best efforts” to sell the startup’s shares.
Black-Scholes Option Pricing Model
Accounting framework used to determine the right price of the startup’s stock options.
Lender’s right to catch up on assets of a debtor besides the normal basis of a lien.
Occurs when a startup has all its preferred shares as equivalent preference rights.
Blue Sky Law
Broad term used to define the State securities legislation.
Person who has the right to participate of a startup’s board meetings as an observer, without the right to vote.
Board of Directors
One or more directors of a startup (the State of Delaware allows a board to be formed of just one person) which form the Board of Directors, whom do not have managing positions. The Board of Directors will take the high level decisions of the company.
Document or part of a standard document, which cannot be negotiated.
Debt instrument in which an investor loans money to an entity (corporate or governmental) for a defined period of time at a fixed interest rate.
The book value of a company is determined by the full amount of its assets minus depreciation and liabilities.
Situation of a startup where the co-founders use their own capital and sales to grow, with no presence of investors.
Fee paid to a potential buyer of a startup when the deal is not complete, for any reason.
Name of a short period investment in a startup that can eventually be replaced or completed with another round of venture capital money. It is normally used for startups grow its equity, building a bridge to the next round.
Rate that measures how much a startup can cover its expenses with the money raised.
A document used to attract potential investors and advisors, describing the idea and how this idea should be implemented and the factors of possible success by numbers.
Agreement used to determine what will happens with a company in case of one of the co-owners leave the company, for any reason. Also, it can be a simple selling agreement between two parties.
Document that determines the rules of internal management of a company.
Right of a holder to buy a number of securities on a certain time, by a determined price.
Notice that a venture capital fund sends to its investors calling them to make a contribution over their capital commitment to the fund.
Every investor in a fund commits to investing a specified sum of money in the fund partnership over a specified period of time. The fund records this as the limited partnership’s capital commitment. The sum of capital commitments is equal to the size of the fund.
These are the returns that an investor in a fund receives. It is the income and capital realized from investments less expenses and liabilities. Once a limited partner has had their cost of investment returned, further distributions are actual profit. The partnership agreement determines the timing of distributions to the limited partner. It will also determine how profits are divided among the limited partners and general partner. Also, it can be the distribution of dividends and profits between the shareholders of a company.
In case of an asset is sold for more than the initial purchase cost, the profit is known as the capital gain. Capital gain refers strictly to the gain achieved once an asset has been sold; an unrealized capital gain refers to an asset that could potentially produce a gain if it was sold
Capital Under Management
The amount of capital that the fund has at its disposal and is managing, for investment purposes.
The share of profits that the fund manager is due once it has returned the cost of investment to investors. Carried interest is normally expressed as a percentage of the total profits of the fund. The industry standard is 20 per cent. The fund manager will normally therefore receive 20 per cent of the profits generated by the fund and distribute the remaining 80 per cent of the profits to investors.
A provision that allows the general partner to take, for a limited period of time, a greater share of the carried interest than would normally be allowed. This continues until the time when the carried interest allocation, as agreed in the limited partnership, has been reached.
A provision which ensures that a general partner does not receive more than its agreed percentage of carried interest over the life of the fund. So, for example, if a general partner receives 21 percent of the partnership’s profits instead of the agreed 20 per cent, limited partners can claw back the extra one per cent.
When fund raising, a firm will announce a first closing to release or drawdown the money raised so far so that it can start investing. A fund may have many closings, but the usual number is around three. Only when a firm announces a final closing is it no longer open to new investors.
If a limited partner in a fund has co-investment rights, it can invest directly in a company that is also backed by the fund. The institution therefore ends up with two separate stakes in the company – one indirectly through the fund; one directly in the company. Some private equity firms offer co-investment rights to encourage institutions to invest in their funds.
The process by which a company buys back the stake held by a financial investor, such as a private equity firm. This is one exit route for private equity funds.
A voluntary and legally-binding agreement between two or more competent parties.
This is the process by which large companies invest in smaller companies.
A written and binding agreement.
This is raising money for working capital or capital expenditure through some form of loan.
A legal document (instrument), by which an asset owner (grantor) transfers rights of ownership (title) in an asset to another party (grantee).
This is a form of finance used to purchase the corporate bonds of companies that have either filed for bankruptcy or appear likely to do so.
Distribution – see capital distribution
Distribution in specie/Distribution in kind
This can happen if an investment has resulted in an IPO. A limited partner may receive its return in the form of stock or securities instead of cash. There can also be restrictions in the US about how soon a limited partner can sell the stock (Rule 144). This means that sometimes the share value has decreased by the time the limited partner is legally allowed to sell.
A dividend is the amount of a company’s profits paid to shareholders each year.
The calculation used to show how much of a company’s after-tax profit is being used to finance the dividend.
The formula is: Dividend Cover=(Earnings per share/Dividend per share).
When a Venture Capital firm has decided where it would like to invest, it will approach its own investors in order to draw down the money. The money will already have been pledged to the fund but this is the actual act of transferring the money so that it reaches the investment target.
A dry closing occurs when a private equity firm raises money for a fund early on in the cycle, but then agrees to not levy any management fees on the money raised from its Limited Partners until it actually begins investing the fund. Most private equity firms will start raising a new fund when their current fund is around 70% invested. Venture firms tend to raise new funds earlier than buy-out firms, because they usually need to invest in follow-on rounds for their portfolio firms.
Investigation, review and analysis of all the deal’s aspects before the signing. Capabilities of the management team, performance record, deal flow, investment strategy and legal, are examples of areas that are fully examined during the due diligence process.
A Venture Capitalist will normally invest in a company when it is in an early stage of development. This means that the company has only recently been established, or is still in the process of being established – it needs capital to develop and to become profitable.
According to ESIGN Act, Section 106:
(2) ELECTRONIC- The term ‘electronic’ means relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities.
(4) ELECTRONIC RECORD- The term ‘electronic record’ means a contract or other record created, generated, sent, communicated, received, or stored by electronic means.
(5) ELECTRONIC SIGNATURE- The term ‘electronic signature’ means an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.
According to UETA, Section 2:
(5) “Electronic” means relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities.
(6) “Electronic agent” means a computer program or an electronic or other automated means used independently to initiate an action or respond to electronic records or performances in whole or in part, without review or action by an individual.
(7) “Electronic record” means a record created, generated, sent, communicated, received, or stored by electronic means.
(8) “Electronic signature” means an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.
Companies seeking to raise finance may use equity financing instead of or in addition to debt financing. To raise equity finance, a company creates new ordinary shares and sells them for cash. The new shareowners become part owners of the company and share in the risks and rewards of the company’s business.
A fund where the returns generated by its investments are automatically channeled back into the fund rather than being distributed back to investors. The aim is to keep a continuous supply of capital available for further investments.
Exit event refers to the investors selling their equity in case of IPO or acquisition of a company.
The price that a startup or an asset (such as a share of common stock) would receive in the open market.
First Time Fund
Is the first fund that a particular private equity firm raises.
Is the total amount of a company’s stock that is outstanding, owned by the public, and available for trading. If the Float is larger, the price of the stock will be more stable as opposed to a small Float, which allows for the possibility of great volatility.
Companies often require several rounds of funding. If a private equity firm has invested in a particular company in the past, and then provides additional funding at a later stage, this is known as ‘follow-on funding’.
Foreign qualification is required if your startup expects to transact business outside the state where you are incorporated. Each state has different requirements and fees associated with Foreign Qualification and these should be taken into account when choosing a state in which to incorporate.
Refers to an anti-dilution protection mechanism whereby the price per share of the preferred stock of a previous investor is adjusted downward due to the issuance of new preferred shares to a new investor at a price lower than the previous investor originally received. The previous investor’s preferred stock is repriced to match the price of new investor’s preferred stock. Usually as a result of the implementation of a Full Ratchet, company management and employees who own a fixed amount of common shares suffer significant dilution.
Fully-diluted basis is the assumption of the highest potential amount of common stock a startup will have outstanding, regardless of vesting provisions and assuming all options and other securities like convertible notes are converted into common stock. That is, assume the highest share count possible given all the outstanding instruments that have the potential to convert into common stock.
A vehicle by which multiple people can invest
Funds usually allow for diversification of investment, a prime example being a mutual fund, which allows for lower risk. Funds are also the investment vehicles used by both VCs and Private Equity firms, or even angel investors. A fund is usually a limited partnership or an LLC.
Fund of Funds
A fund set up to distribute investments among a selection of private equity fund managers, who in turn invest the capital directly. Fund of funds are specialist private equity investors and have existing relationships with firms. They may be able to provide investors with a route to investing in particular funds that would otherwise be closed to them. Investing in fund of funds can also help spread the risk of investing in private equity because they invest the capital in a variety of funds.
The process by a private equity firm solicits financial commitments from limited partners for a fund. Firms typically set a target when they begin raising the fund and ultimately announce that the fund has closed at such-and-such amount.
Specialist advisers who assist institutional investors in their private equity allocation decisions. Institutional investors with little experience of the asset class or those with limited resources often use them to help manage their private equity allocation. Gatekeepers usually offer tailored services according to their clients’ needs, including private equity fund sourcing and due diligence through to complete discretionary mandates. Most gatekeepers also manage funds of funds.
This can refer to the top-ranking partners at a private equity or a venture capital firm as well as the firm managing the private equity fund.
General Partner contribution/commitment.
The amount of capital that the fund manager contributes to its own fund. This is an important way for limited partners to ensure that their interests are aligned with those of the general partner. The US Department of Treasury recently removed the legal requirement of the general partner to contribute at least one per cent of fund capital, but this is still the usual contribution.
Is the term given for compensation packages given to upper level executives that are triggered if the executive is terminated, generally due to a change in control (merger or acquisition). These packages usually include stock options or a large cash bonus and sometimes serve as a small deterrent to corporate takeovers.
A fund that can use one or more alternative investment strategies, including hedging against market downturns, investing in asset classes such as currencies or distressed securities, and utilizing return-enhancing tools such as leverage, derivatives, and arbitrage.
Refers to the general shape of a graph showing revenue that increases dramatically at some point in the future. Startups often use business plans with Hockey Stick charts to impress potential investors.
This is the length of time that an investment is held.
Is the minimum rate of return required by an investor. A fund manager may not be able to collect fees until the Hurdle Rate is reached.
An entity designed to nurture business ideas or new technologies to the point that they become attractive to venture capitalists. An incubator typically provides physical space and some or all of the services – legal, managerial, technical – needed for a business idea to be developed. Private equity firms often back incubators as a way of generating early-stage investment opportunities.
Refers to the compensation of one party to a contract by another party to the contract for a loss or damage incurred from a third-party. Indemnification provisions have become commonplace in contracts of all kinds.
Is the maximum amount that a buyer may recoup from a seller for damages due to deviations from the reps and warranties in the purchase/acquisition agreement. There can be multiple indemnification caps for certain types of reps and warranties (such as intellectual property).
Undertaking given to compensate for injury, loss, incurrent penalties and liabilities.
Institutional Buy-Out (IBO)
If a private equity firm takes a majority stake in a management buy-out, the deal is an institutional buy-out. This is also the term given to a deal in which a private equity firm acquires a company out right and then allocates the incumbent and/or incoming management a stake in the business.
Initial Public Offering (IPO)
An IPO is the official term for ‘going public’. It occurs when a privately held company – owned, for example, by its founders plus perhaps its private equity investors – lists a proportion of its shares on a stock exchange. IPOs are an exit route for private equity firms. Companies that do an IPO are often relatively small and new and are seeking equity capital to expand their businesses.
Internal Rate of Return (IRR)
This is the most appropriate performance benchmark for private equity investments. In simple terms, it is a time-weighted return expressed as a percentage. IRR uses the present sum of cash drawdowns (money invested), the present value of distributions (money returned from investments) and the current value of unrealized investments and applies a discount.
The general partner‘s carried interest may be dependent on the IRR. If so, investors should get a third party to verify the IRR calculations.
Describes the normal situation in liquidations where those who were the last to invest get paid before those who invested earlier. The new investors usually have leverage to require this situation.
Later Stage Finance
Capital that private equity firms generally provide to established, medium-sized companies that are breaking even or trading profitably. The company uses the capital to finance strategic moves, such as expansion, growth, acquisitions and management buy-outs.
The investor that usually, but not always, makes the largest investment in a financing round and manages the documentation and closing of that round. The Lead Investor generally negotiates the valuation of the startup and all other material terms.
A letter written by the lawyer of a startup, that gives certain assurances that the startup’s representations and warranties. A Legal Opinion is generally given during a financing to the VCs and other investors.
Leveraged Buy-Out (LBO)
The acquisition of a company using debt and equity finance. As the word leverage implies, more debt than equity is used to finance the purchase, e.g. 90 per cent debt to ten per cent equity. Normally, the assets of the company being acquired are put up as collateral to secure the debt.
Institutions or individuals that contribute capital to a private equity fund. LPs typically include pension funds, insurance companies, asset management firms and fund of fund investors.
The standard vehicle for investment in private equity funds. A limited partnership has a fixed life, usually of ten years. The partnership’s general partner makes investments, monitors them and finally exits them for a return on behalf the investors – limited partners. The GP usually invests the partnership’s funds within three to five years and, for the fund’s remaining life, the GP attempts to achieve the highest possible return for each of the investments by exiting. Occasionally, the limited partnership will have investments that run beyond the fund’s life. In this case, partnerships can be extended to ensure that all investments are realized. When all investments are fully divested, a limited partnership can be terminated or ‘wound up’.
Process to bring a business to an end.
A multiple on the amount invested in a given round.
A provision in the underwriting agreement between an investment bank and existing shareholders that prohibits corporate insiders and private equity investors from selling at IPO.
When a team of managers buys into a company from outside, taking a majority stake, it is likely to need private equity financing. An MBI is likely to happen if the internal management lacks expertise or the funding needed to ‘buy out’ the company from within. It can also happen if there are succession issues – in family businesses, for example, there may be nobody available to take over the management of the company. An MBI can be slightly riskier than a MBO because the new management will not be as familiar with the way the company works.
Management Buy-Out (MBO)
A private equity firm will often provide finance to enable current operating management to acquire or to buy at least 50 per cent of the business they manage. In return, the private equity firm usually receives a stake in the business. This is one of the least risky types of private equity investment because the company is already established and the managers running it know the business – and the market it operates in – extremely well.
This is the annual fee paid to the general partner. It is typically a percentage of limited partner commitments to the fund and is meant to cover the basic costs of running and administering a fund. Management fees tend to run in the 1.5 per cent to 2.5 per cent range, and often scale down in the later years of a partnership to reflect the GP’s reduced workload. The management fee is not intended to incentivize the investment team – carried interest rewards managers for performance.
This is the term associated with the middle layer of financing in leveraged buy-outs. In its simplest form, this is a type of loan finance that sits between equity and secured debt. Because the risk with mezzanine financing is higher than with senior debt, the interest charged by the provider will be higher than that charged by traditional lenders, such as banks. However, equity provision– through warrants or options – is sometimes incorporated into the deal.
A private equity firm will invest in several companies, each of which is known as a portfolio company. The spread of investments into the various target companies is referred to as the portfolio.
This is one of the companies backed by a private equity firm.
Placement agents are specialists in marketing and promoting private equity funds to institutional investors. They typically charge two per cent of any capital they help to raise for the fund.
This is the minimum amount of return that is distributed to the limited partners until the time when the general partner is eligible to deduct carried interest. The preferred return ensures that the general partner shares in the profits of the partnership only after investments have performed well.
Stock that entitles the holder to a fixed dividend, whose payment takes priority over that common stock dividends.
This refers to the holding of stock in unlisted companies – companies that are not quoted on a stock exchange. It includes forms of venture capital and MBO financing.
A term used in the US to refer to private equity investments.
When securities are sold without a public offering, this is referred to as a private placement. Generally, this means that the stock is placed with a select number of private investors.
Public to Private
This is when a quoted company is taken into private ownership – more recently by private equity firms. Historically, this has involved a large company selling one of its divisions. A new trend has been for whole companies to be bought out and subsequently delisted.
This is a structure that determines the eventual equity allocation between groups of shareholders. A ratchet enables a management team to increase its share of equity in a company if the company is performing well. The equity allocation in a company varies, depending on the performance of the company and the rate of return that the private equity firm achieves.
This refers to a change in the way a company is financed. It is the result of an injection of capital, either through raising debt or equity.
The term for the market for interests in VC and private equity limited partnerships from the original investors, who are seeking liquidity of their investment before the limited partnership terminates. An original investor might want to sell its stake in a private equity firm for a variety of reasons: it needs liquidity, it has changed investment strategy or focus or it needs to re-balance its portfolio. The main advantage for investors looking at secondaries is that they can invest in private equity funds over a shorter period than they could with primaries.
A common exit strategy. This type of buy-out happens when an investment firm’s holding in a private company is sold to another investor. For example, one venture capital firm might sell its stake in a private company to another venture capital firm.
The market for secondary buy-outs. This term should not be confused with secondaries.
Second Stage Funding
The provision of capital to a company that has entered the production and growth stage although may not be making a profit yet. It is often at this stage that venture capitalists become involved in the financing.
The provision of very early stage finance to a company with a business venture or idea that has not yet been established. Capital is often provided before venture capitalists become involved. However, a small number of venture capitalists do provide seed capital.
Sliding Fee Scale
A management fee that varies over the life of a partnership.
These are captive or semi-captive firms that gain independence from their parent organizations.
An investment that a corporation makes in a young company that can bring something of value to the corporation itself. The aim may be to gain access to a particular product or technology that the start-up company is developing, or to support young companies that could become customers for the corporation’s products. In venture capital rounds, strategic investors are sometimes distinguished from venture capitalists and others who invest primarily with the aim of generating a large return on their investment. Corporate venturing is an example of strategic investing.
The sharing of deals between two or more investors, normally with one firm serving as the lead investor. Investing together allows venture capitalists to pool resources and share the risk of an investment.
A summary sheet detailing the terms and conditions of an investment opportunity.
When a private equity firm has raised a fund, or it wishes to announce a significant closing, it may choose to advertise the event in the financial press – the ad is known as a tombstone. It normally provides details of how much has been raised, the date of closing and the lead investors.
Turnaround finance is provided to a company that is experiencing severe financial difficulties. The aim is to provide enough capital to bring a company back from the brink of collapse. Turnaround investments can offer spectacular returns to investors but there are drawbacks: the uncertainty involved means that they are high risk and they take time to implement.
The term given to early-stage investments. There is often confusion surrounding this term. Many people use the term venture capital very loosely and what they actually mean is private equity.
The year in which a private equity fund makes its first investment.