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Cap table, Corporate Finance and Fundraisings: Glossary of Terms
This glossary explains most terms used in the funding process for early stage companies, and for capitalisation tables (cap tables). Capitalised terms refer to other terms in this glossary.
Angel Investors (see also Return): angel investors are individuals, groups or syndicates, that invest in early stage companies. Usually on their own behalf using their own money. They can be people you know already - "Friends and Family"; or formal groups that specialise in making angel investments
Anti-dilution: (in context of Share Options) an anti dilution clause, or principle, will ensure that the number of shares in a option round is increased at each subsequent fundraising, to ensure that the total size of the option round as a percentage of the company stays the same, e.g. at 10%. To be effective, this requires agreement from incoming, new investors
Articles of Association: a document, which sets out the legal and economic structure of the company. Put in place at the founding of the company
Break-Even: whether a company is making more money than it is spending
Business Plan: a long-form document, typically running to 30-50 pages, setting out the strategy of the company. Covering what the company intends to do, how it will do this, and what it needs to get there. Contrasting to any competition that may currently exist, and threats to the achievability of the plan. Business Plans are most frequently requested by banks and government bodies (e.g. for tax, compliance etc); with Investor Decks becoming more common for earlier stage companies. Business Plans are similar to Information Memorandums.
Cap table or Capitalisation Table: a description of the Shareholders of a company. Setting out the number of Shares held and the percentage ownership of the company for each Investor
Capex: capital expenditure. Money spent by a company on acquiring assets for use in their business
Cash Headroom: the number of months cash a company has before it runs out of money
CFADS: Cash flow available for debt service. EBITDA less Capex less Investment in working capital less Tax
Corporate Finance: anything associate with the raising of Equity or Debt capital for a company. A Corporate Finance firm specialises in assisting companies with raising capital.
Conversion Ratio (see also Convertible Debt): the number of shares a convertible debt holder can convert $1,000 of debt for. Conversion Ratio = $1,000 / Price per Share
Convertible Debt: debt finance that has the ability to convert into Equity at a point in the future. Convertible Debt instruments are used by early stage companies in North America when they first raise funding. This enables them to raise money over time (heard investment) and avoid addressing the Valuation question with early investors. Although avoiding setting a valuation can create as many problems as you are seeking to avoid.
The convertible debt instrument will set out clear parameters for how and when conversion into equity may take place.
- Conversion set by reference to the next equity funding round: when the next (or first) equity round is raised, the debt may convert at a set discount to the valuation ("Discount") used for the the new equity investors; subject to a maximum valuation ("Valuation Cap")
- Conversion set by reference to the share price of the company: the debt may convert based on a set number of shares per $1,000 of nominal value of debt (the "Conversion Ratio"). When a company's share price rises sufficiently, the debt holder may choose to convert to equity, enabling them to gain a bigger return
In addition, the convertible debt may also benefit from interest until the date of conversion. When the debt is converted, for example as part of a Series A fundraising, the debt holders will usually benefit from the same economic terms as the Series A investors going forward
Covenants or Covenant Tests (see also Debt): usually a Lender to a company will set performance targets to protect their investment. These performance targets are known as Covenants, and can take a variety of forms. Three of the most common Covenants are:
- Net worth or net leverage = Net Debt / EBITDA
- Cash flow cover = Net Cash Flow from a company's operations (CFADS) / Debt Service
- Interest Cover = EBITDA / Interest charges
The level that these covenants are set at, will be calculated by reference to a Business Plan or Financial Plan made by the company. The lender will review this plan and allow a percentage of under performance. Depending on the stage of the company, and how much it has borrowed, this percentage under performance can be as small as 10% or as high as 50%.
Debt (see also Equity): money which has been borrowed by the company, which needs to be repaid with Interest. Debt can be Secured or Unsecured
Debt Service: the total debt Interest Charges and debt Principle Repayment in a period
Enterprise Value = Equity Value + Net Debt
Equity Value: the value of all the shares of the company:
Equity Value = Share Price x Total Number of Shares Outstanding
Event of Default: this can be as basic as a Company not repaying its Debts as they fall due, or making its interest payments. But it can be more technical - for example, if the Covenants aren't met then a covenant breach occurs. This will trigger an "Event of Default". But an Event of Default could also occur if a Covenant breach is simply forecast, e.g. it hasn't even occurred yet!
Exit: the point at which all, or most, existing investors in a company are able to obtain a Return on their investment
Exit Valuation: the value of the company at exit. The price paid by a new owner if acquired through M&A, or the valuation placed on the company through an IPO process
Financial Plan: a numerically-orientated plan which projects the performance of the company. Setting out key milestones, and resources required to get there. Projections are usually set out monthly for 12 months, and then annually thereafter for a further 2-4 years.
Fully Diluted Share Price = Equity Value / (Total number of Shares in issue + new shares that may need to be issued for options + new shares that may need to be issued for convertible debt)
Information Memorandum (IM): a long-form document that assists with the sale, or significant fundraising, for a company. A Corporate Finance firm or accountancy firm may assist with the preparation of the IM
Interest Charges: the amount of interest payable (or Interest Rolled Up) on a Debt Instrument or Security
Interest Rate: the annual rate of interest accruing on a debt instrument, or preferred share
Interest Rolled Up: the amount of interest due, but not paid yet, on a debt instrument
Investment Committee: a group of individuals that will decide which companies that want to invest in, and on what basis. Investment Committee are present in VCs in Banks, and may not include the individual who deals directly with a company that is seeking the investment
Investment Agreement: a document, or set of legal documents, which sets out the basis on the new investors are providing capital, and any condition attaching to the running of the company as a result
Investor Deck: a short form presentation, typically 10-15 slides, setting out the objectives of the company, and the key characteristics of a current fundraising
Investor Director: a director of the company, which has been appointed by an investor, or group of investors, pursuant to the Investment Agreement or Articles of Association (UK)
IRR (Internal Rate of Return): the annual return achieved by an Investor, or Security. This is calculated by looking at all the cash flows (in and out) for that Investor or Security, and the dates of those investments
Leaver Provisions (see also Share Options): regardless of the Vesting Schedule; the Share Options or Shares awarded to an employee may be subject to Leaver Provisions. This enables the company to protect itself in the event that en employee leaves and goes to a competitor, or damages the value of the company by leaving
Liquidation Preference: when a later stage investor comes in, for example a VC investing as part of a Series A or Series B round; they will often seek a Liquidation Preference. This means, that they will get paid back first out of any proceeds in the event of a sale of the company. They may get paid back a multiple of their original investment, before any other investor receives a Return. Once they have been paid back their Liquidation Preference, then other investors may start receiving a return
Liquidation Preference Chart: a chart which sets out the return to each Investor, or each Security, across a range of Exit Valuations
Money Multiple or Multiple of Money (MoM) (see also Return): the return made by an investor expressed as a fraction: total amount of money returned / total amount of money invested. This is also know as the cash-on-cash return
Net Debt: the net borrowings of the company:
Net Debt = Long-term borrowings + Short-term borrowing - Cash (- Investments where applicable)
Non-Executive Directors (NXD or NED): directors of the company who do not work in the company full-time. They generally hold a board position only, so will attend board meetings and liaise with the senior management team with any major issues that may arise
Nominal Share Price: the book value of each share. This is set at the outset of the company formation, and is typically 0.01c or $1 - bearing little relation to the economic value of the company
Option Pool or Option Round: the total number of shares set aside for allocating to senior management and employees; including new joiners
Option Pool Shuffle: when a VC invests, a pre-money valuation will be agreed between the Founders and the Investors. Often, an option pool of 5%-20% will be put in place to incentivise the management team and employees:
- If the pre-money valuation includes the dilution effect of the new option pool, then that is worse for the Founder and better for the Investors. As the Investors won't be diluted by the new Option Pool. Investors often argue that they want the pre-money valuation to be Fully Diluted, as the reason for including the dilution in the pre-money valuation
- If the pre-money valuation excludes the dilution effect of the new option pool, then it is better for the Founder and worse for the Investors. As both the Investors and the Founders will be diluted by the new Option Pool. Founders should argue that the positive impact from the new Option Pool will benefit the new investors, and so they should also be diluted by the new Option Pool
Both approaches are common, and moving the order of the Option Pool dilution, is known as the "Option Pool Shuffle"
Ordinary Shares: the ordinary chares of a company, often with few special rights attaching to them. The Founders' shares and Angel shares are usually Ordinary Shares
Participating (or Participating Preferred): (see also Liquidation Preference) where an investor has a Liquidation Preference, and Participation rights, then they will get the first proceeds back, but will also gain in value as soon as the other ordinary shareholders get a return. If the Investor doesn't have Participation, but does have a Liquidation Preference, then after the Investor has received a return from their Liquidation Preference, they need to wait for the ordinary shareholders to "catch up"; before sharing in any further upside
Post-Money Valuation = Pre-Money Valuation + Equity Cash Invested
Principal Repayment: the amount of loan principal paid down in a period
- Angel investors: angel investors like to be able to see a 5-10x Money Multiple on each investment. Allowing for a majority of companies failing, the average long-run returns for angel investors is a 2.5x
- Seed investors: seed investors are a little later stage than angel investors, but not significantly so. So their return expectations will be similar to Angel Investors
- VC investors: in general, VCs will want to achieve a 2.5-3x Money Multiple on their original investment across their entire VC Fund. However, the distribution of returns across the 15-30 investments made out of each fund may vary significantly, with a number being full loses. So, for each investment, the VC will target a minimum of a 4-5x return
Secured Debt: debt which does have security over the Shares or assets of the company. In thee Event of Default
Security or Instrument: an investment instrument. This can be Equity or Debt
Series A, Series B, Series C, Series D etc: the first round of investment a VC makes is usually "Series A". This reflects a particular stage early-on in the company's growth. Usually post-revenue, but pre-profitability. Subsequent rounds are then labeled in alphabetical order; but again, will reflect certain stages of a company's growth. As each round will usually give a company a similar time to grow - 9 to 15 months of Cash Headroom (if they aren't yet beyond Break-Even)
Shares: a company's Equity is split into Shares. These may be in one Share Class, or a number of share classes, with different rights attaching to them.
Share Certificate: a document which sets out the shareholding of an individual investor
Share Class(es): different share classes will have different rights attaching to them. The key distinctions are different voting rights - the ability to exert control over a company; or economic rights - the ability to share in the proceeds of a sale or divided distribution from the company. A company may have many different classes of share, reflecting the different types of fundraising that they have undertaken
Share Options: the right but not the obligation to buy shares at a date in the future. The Share Option holder will need to pay an amount for these shares, which will be less than market value when they exercise their options (choose to buy shares). The company will need to issue new shares to the Share Option holder if they exercise their option.
Share options are usually awarded to employees, with the Strike Price set to reflect the value of the company when they join (or when the share options are issued). Share Options are often subject to Vesting and Leaver Provisions
Unallocated Options: share options not yet allocated to an employee
Unsecured Debt: debt which does not take Security over the Shares or assets of the company. In the Event of Default, the lenders cannot enforce security, so are unable to force repayment by way of liquidation. Although they do retain their right to be repaid, and so are treated as a typical creditor of the company
Unvested Options: share options allocated, but not yet vested to an employee (see Vesting)
Valuation Cap (see also Convertible Debt): the maximum Pre-Money Valuation at which a convertible debt instrument will convert
Venture Capital: money used to invest in early stage companies in exchange for Shares, with the objective of getting a Return on that investment
- Annually at end of year: at each anniversary, the employee gets to keep a portion of their Share Options. A typical period for annual vesting is 4 years - so 25% is retained at the end of each year
- Annually at start of year: at each anniversary, and on the date of award, the employee gets to keep a portion of the Share Options. So if the vesting period is 4 years, they get 20% at each vesting date
- Monthly: as above except the employee gets 1/48th of their award every month. This has the benefit of removing any vesting "cliffs" - which make focus an employee (or employers) focus
- Fully vest at exit: the vesting schedule may include a "catch-all" term - if the company is sold and the employee is still at the company, then the employee gets to keep all the Share Options awarded to them - i.e. "Fully Vest"
Venture Capitalists: a person or organisation that makes Venture Capital investments. Usually investing on behalf of other investors, such as pension funds, insurance companies, endowments, and other financial institutions, aggregated through a VC Fund
VC Fund: a VC will invest out of a number of funds, raised over time, and sometimes each fund may have a different investment objective. The fund will usually have a 5-year investment window (they must make all investments in new companies within 5 years) and a 8-10 year horizon (so all investments need to be sold or Exited at the end of the 10 years). The timing starts when the fund is raised, not when the first investment is made, or when the investment each company is made