Embarking on the journey of securing early-stage financing for your startup is an exciting but complex endeavor. To successfully navigate this terrain, it’s crucial to familiarize yourself with the key jargon used by investors, as these terms play a pivotal role in shaping the terms of your relationship with them.
Remember, obtaining funding from investors is akin to entering a long-term commitment, and understanding the intricacies of these terms is vital to maintaining control, equity, and securing profits on exit.
Terms Every Entrepreneur Should Know
1. Term Sheet:
- Definition: The document outlining the terms on which the investor will invest in the company.
- Role: Serves as an agreement defining the relationship between the investor and entrepreneur, particularly concerning economics and control.
2. Pre Money Valuation & Post Money Valuation
- Pre Valuation: The value of the company before receiving funding.
- Post Valuation: The value of the company after receiving funding.
- Importance: Understanding these values is crucial for determining the impact of funding on your company’s overall worth.
3. Type of Stocks
- Preferred Stock: Shares given to investors with preferential treatment, especially during events like liquidation.
- Series A, B, C: Different classes of preferred stock issued at each funding round.
4. Liquidation Preferences
- Definition: The order in which stakeholders are paid out during a liquidity event.
- Importance: Determines the hierarchy of payment, usually follows the order of creditors, preferred stock, and common stock.
5. Option Pool
- Definition: Shares reserved for future hires.
- Impact: Affects the company’s valuation and dilution.
- Calculation: Expressed in post-money valuation but included in pre-money valuation.
- Definition: A schedule imposed on founders and employees to ensure commitment to the organization for a specified period.
- Importance: Prevents early departure and loss of equity.
As an example, let’s consider a scenario where an investor injects $1 million at a $5 million pre-valuation, resulting in a post-valuation of $6 million. With a 20% option pool, the entrepreneur’s stake will be diluted. Understanding these dynamics is crucial for maintaining a clear perspective on your ownership stake.
In essence, mastering these terms is akin to equipping yourself with the language of the funding landscape, ensuring you enter into agreements that align with your goals and aspirations as an entrepreneur.
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