10 Terms You Must Know Before Raising Startup Capital

12/1/2014
10 Terms You Must Know Before Raising Startup Capital
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J.J. Colao (http://www.forbes.com/sites/jjcolao/) Contributor
All of the blood, sweat and tears of startups.

Opinions expressed by Forbes Contributors are their own.
ENTREPRENEURS (/ENTREPRENEURS)
10/14/2013 @ 1:32PM 62,312 view s
10 Terms You Must Know

Before Raising Startup Capital
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There are a lot of ways to get tripped up while

building a company. Failing to understand financial
jargon shouldnt be one of them.
Its not that investors and venture capitalists are evil
or anything. Its just that their interests dont
perfectly align with those of entrepreneurs. You
want to build a company, keep control and earn a fair
share of any windfall. Investors want to profit from
your company as much as possible, minimize their
financial risk and, often, gain the operating control
needed to do so. Balancing these interests is a
delicate process that requires a clear-eyed
understanding of the terms involved during negotiations.
So in the tsunami of legalese that entrepreneurs face during fundraising
discussions, FORBES has uncovered 10 terms that we think are essential to
understand. A familiarity with the phrases below will help you avoid needlessly
giving up equity, control and profits in the event of a successful exit. This post
is no replacement for a lawyer, but it will help you, hopefully, call BS on lessthan-forthcoming investors. (For a quick summary of the terms, check out the
full list here (http://www.forbes.com/pictures/elld45eefhf/premoney-vs-post-money-valuation/).)
Pre-money vs. Post-money Valuation
Lets start very simply: valuation is the monetary value of your company.
Internally, company shareholders often agree on a formula to determine
valuation in the event of a partners death or exit. When looking for venture or
angel financing, your valuation is, frankly, whatever you can convince
investors to agree on.
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The difference between pre-money valuation and post-money valuation is also

very simple. Pre-money refers to your companys value before receiving
funding. Lets say a venture firm agrees to a pre-money valuation of $10
million for your company. If they decide to invest $5 million, that makes your
companys post-money valuation $15 million.
Post-money valuation = pre-money valuation +
new funding
These terms are important because they determine
the equity stake youll give up during the funding
round. In the above example, the investors $5
million stake means hes left with 33% ownership of
the company ($5 million/$15 million).
Lets consider a counterexample. Say the company
was valued at $10 million post-money instead,
implying a $5 million pre-money valuation. This
means that the investors $5 million counts as half
the companys valuation. He comes away with 50%
of the company in this scenario, rather than 33%. Given the difference in
equity, you can see how important it is clarify between pre and post-money
valuations when discussing investment terms.
Convertible Debt (Convertible Notes)
When a company is young, quantifying its valuation is often an arbitrary,
pointless exercise. There may not even be a product in hand, let alone revenue.
But companies at this stage may still need to raise money, and if investors
decide on a pre-money valuation of say, $100,000, another $100,000
suddenly buys control.
Convertible debt (also called convertible notes) is a financing vehicle that
allows startups to raise money while delaying valuation discussions until the
company is more mature. Though technically debt (see this post on
convertible equity (http://www.forbes.com/sites/jjcolao/2012/08/31/adeoressi-introduces-convertible-equity-convertible-debt-without-debt/) for a
further explanation) convertible notes are meant to convert to equity at a later
date, usually a round of funding. (Often notes convert to equity during a Series
A round of funding.)
Investors who agree to use convertible notes generally receive warrants or a
discount as a reward for putting their money in at the earliest, riskiest stages of
the business. In short, this means that their cash converts to equity at a more
favorable ratio than investors who come in at the valuation round. I wont go
into detail on warrants and discounts here, but Fred Wilson, a venture
capitalist at Union Square Ventures, provides a nice explanation of these
terms on his blog (http://www.avc.com/a_vc/2011/07/financing-optionsconvertible-debt.html).
Capped Notes vs. Uncapped Notes
As discussed above, convertible notes delay placing a valuation on a company
until a later funding round. But investors often still want a say in the future
valuation of the company so their stake doesnt get
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diluted down the line. When entrepreneurs and

investors agree to a capped round, this means that
they place a ceiling on the valuation at which
investors notes convert to equity.
So if a company raises $500,000 in convertible
notes at a $5 million cap, those investors will own at
least 10% of the company after the Series A round
($500,000/$5M).
An uncapped round means that the investors get no
guarantee of how much equity their convertible debt
investments will purchase, making these kinds of
investments most favorable for the entrepreneur. Lets consider a company
that raises $500,000 in an uncapped round. If they end up making so much
progress that they convince Series A investors to agree to a $10 million, this
means that their convertible note investors are left with just 5% of the
company, half of what they would get if they capped the round at $5
million. (For the sake of simplicity, were ignoring discounts and warrants
here.)
Again, you can see how important these distinctions are in terms of retaining
ownership of your company.
Follow me @JJColao (http://twitter.com/jjcolao) and on Facebook
(http://www.facebook.com/JJ.Colao). Also try me at Haymaker.
(http://www.haymaker.co/)
10 Terms You Must Know Before Raising
Venture Capital
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(http://www.forbes.com/pictures/elld45eefhf/convertibledebt/)
Pre-money vs. Post-money Valuation

So lets start very simply: valuation is the monetary
value of your company.The difference between premoney valuation and post-money valuation is also very
simple. Pre-money refers to your companys value
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The 10 Best Venture Capitalist

Blogs For Entrepreneurs
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In the increasingly competitive world of venture capital, it pays to be helpful

literally. To get in on the best deals, VCs need to be seen as smart, insightful
and supportive. And since VCs are all about scale, what better way to do that
than a blog?
This is good news for entrepreneurs, because despite the bad rep that the
venture industry gets (these guys are technically in finance after all) VCs
occasionally know what theyre talking about. Whether youre looking
for recruiting strategies, pricing models, a glimpse into an industrys future or
tips for pitching, odds are that a VC has a post for it.
The picks here are based on a very unscientific methodmy own judgment of
bloggers frequency and content quality. (Posts that lack any evergreen value
whatsoever, like those celebrating the funding of a portfolio company, do not
count in either case.) For this reason I left off some more popular names, like
Dave McClure and David Hornik, in favor of lesser-known VCs who have
posted better content more regularly. The list here is weighted in favor of
smart analysis or directly applicable advice rather than anecdotes and
assertions.
For those of you who follow the space closely, many of the names in the full
list below (http://www.forbes.com/pictures/elld45mlkj/fredwilson-a-vc/) will likely be familiar. But here are a couple that might be new:
Tomasz Tunguz ex post facto (http://tomtunguz.com/)
Tunguz, a principal at Redpoint Ventures, relies on short, punchy posts to get
his point across. His penchant for expressing ideas in terms of frameworks
(see: The Three Phases of Startup Sales (http://tomtunguz.com/the-threephases-of-startup-sales) or The Five Characteristic of an Ideal SaaS
Company (http://tomtunguz.com/five-characteristics-of-an-ideal-saascompany)) makes for effective, easily digestible pieces.
Standout Post: The Compounding Returns of Content Marketing
(http://tomtunguz.com/compounding-blogging)
David Skok For Entrepreneurs (http://www.forentrepreneurs.com/)
Matrix Partners David Skok only blogs a couple of times a year, but the
resources available in that small pool of posts make for a virtual textbook of
financial models and startup strategies. If you prefer Excel over anecdotes,
Skoks blog is a treasure trove of charts, graphs and equations. In terms of
directly applicable MBA-level insights, For Entrepreneurs
(http://www.forbes.com/entrepreneurs/) is unmatched.
Standout Post: SaaS Metrics 2.0 (http://www.forentrepreneurs.com/saasmetrics-2/)
Chris Dixon Cdixon.org (http://cdixon.org/)
A New York entrepreneur and seed investor turned Silicon Valley VC, Dixon
likes to take the macro view. Many of his posts consider industry-wide trends,
then examine the consequences of those trends for entrepreneurs. Some
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noteworthy insights: app stores have trained consumers to expect cheap

software, while startups going after popular incumbents (like Craigslist) are
better off focusing on niche products.
Standout Post: Some Thoughts on Mobile
(http://cdixon.org/2013/06/01/some-thoughts-on-mobile/)
First Round Capital The Review (http://firstround.com/article/themanagement-framework-that-propelled-LinkedIn-to-a-20-billion-company)
The Review is a bit of an outlier on this list. A compilation of startup-centric
content rather than the musings of an individual VC, the Review is First
Round Capitals attempt at creating a Harvard Business
(http://www.forbes.com/business/) Review for startups. (Its also the most
comprehensive attempt at content marketing in the industry.) The Reviews
preferred mode of instruction: case studies on the experiences of individual
entrepreneurs and companies.
Standout Post: The management framework that propelled LinkedIn to a $20
billion company (http://firstround.com/article/the-management-frameworkthat-propelled-LinkedIn-to-a-20-billion-company)
Follow me @JJColao (http://twitter.com/jjcolao) and on Facebook
(http://www.facebook.com/JJ.Colao).
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