a financing event whereby angel groups and / or venture capitalists become involved in a fast growth company that was previously financed by founders and their friends and families.
a person or legal entity, such as a company or trust fund, that meets certain net worth and income qualifications and is considered to be sufficiently sophisticated to make investment decisions in private offerings. Regulation D of the Securities Act of 1933 exempts accredited investors from protection of the Securities Act. The Securities and Exchange Commission has proposed revisions to the accredited investor qualifying rules, which may or may not result in changes for venture investors. The current criteria for a natural person are: $1 million net worth or annual income exceeding $200,000 individually or $300,000 with a spouse. Directors, general partners and executive officers of the issuer are considered to be accredited investors.
The process of taking over a controlling interest in another company. Acquisition also describes any deal where the bidder ends up with 50 per cent or more of the company taken over.
Companies often need to use external finance to fund an acquisition. This can be in the form of bank debt and/or equity, such as a share issue.
An advisory board is common among smaller companies. It is less formal than the board of directors. It usually consists of people, chosen by the company founders, whose experience, knowledge and influence can benefit the growth and direction of the business. The board will meet periodically but does not have any legal responsibilities in regard to the company.
After-tax operating income
see Net operating income after taxes.
a loan whose value exceeds the value of the collateral.
a term derived from statistics and finance theory that is used to describe the return produced by a fund manager in excess of the return of a benchmark index. Manager returns and benchmark returns are measured net of the risk-free rate. In addition, manager returns are adjusted for the risk of the manager's portfolio relative to the risk of the benchmark index. Alpha is a proxy for manager skill.
Non-traditional asset classes. They include private equity, venture capital, hedge funds and real estate. Alternative assets are generally more risky than traditional assets, but they should, in theory, generate higher returns for investors.
a wealthy individual that invests in companies in relatively early stages of development. Usually angels invest less than $1 million per startup.
a contract clause that protects an investor from a substantial reduction in percentage ownership in a company due to the issuance by the company of additional shares to other entities. The mechanism for making an adjustment that maintains the same percentage ownership is called a Full Ratchet. The most commonly used adjustment provides partial protection and is called Weighted Average.
Anything owned by an individual, a business or financial institution that has a present or future value i.e. can be turned into cash. In accounting terms, an asset is something of future economic benefit obtained as a result of previous transactions. Tangible assets can be land and buildings, fixtures and fittings; examples of intangible assets are goodwill, patents and copyrights.
The percentage breakdown of an investment portfolio. This shows how the investment is divided among different asset classes. These classes include shares, bonds, property, cash and overseas investments. Institutions structure their allocation to balance risk and ensure they have a diversified portfolio. The asset classes produce a range of returns - for example, bonds provide a low but steady return, equities a higher but riskier return. Cash has a guaranteed return. Effective asset allocation maximises returns while covering liabilities.
a financing event whereby investors such as venture capitalists and organized angel groups are sufficiently interested in a company to provide additional funds after the "A" round of financing. Subsequent rounds are called "C", "D" and so on.
A fund that spreads its investments between various types of assets such as stocks and bonds. Investors can avoid excessive risk by balancing their investments in this manner, but should expect only moderate returns.
a relatively large principal payment due at a specific time as required by a lender.
Basis point ("bp")
one one-hundredth (1/100) of a percentage unit. For example, 50 basis points equals one half of one percent. Banks quote variable loan rates in terms of an index plus a margin and the margin is often described in basis points, such as LIBOR plus 400 basis points (or, as the experts say, "beeps").
This is a standard measure used to assess the performance of a company. Investors need to know whether or not a company is hitting certain benchmarks as this will determine the structure of the investment package. For example, a company that is slow to reach certain benchmarks may compensate investors by increasing their stock allocation.
Best efforts offering
a commitment by a syndicate of investment banks to use best efforts to ensure the sale to investors of a company's offering of securities. In a best efforts offering, the syndicate avoids any firm commitment for a specific number of shares or bonds.
a measure of volatility of a public stock relative to an index or a composite of all stocks in a market or geographical region. A beta of more than one indicates the stock has higher volatility than the index (or composite) and a beta of one indicates volatility equivalent to the index (or composite). For example, the price of a stock with a beta of 1.5 will change by 1.5% if the index value changes by 1%. Typically, the S&P500 index is used in calculating the beta of a stock.
a product that is being tested by potential customers prior to being formally launched into the marketplace.
see Cram-down round.
regulations in individual states regarding the sale of securities and mutual funds. These laws are intended to protect investors from purposely fraudulent transactions.
Board of directors
a group of individuals, typically composed of managers, investors and experts who have a fiduciary responsibility for the well being and proper guidance of a corporation. The board is elected by the shareholders.
a person, project or activity that hinders the growth of a company.
see Private placement memorandum.
the lead bank that manages the transaction process for an equity or debt financing, including documentation, syndication, pricing, allocation and closing.
the book value of a company is the value of the common stock as shown on its balance sheet. This is defined as total assets minus liabilities minus preferred stock minus intangible assets. The book value of an asset of a company is typically based on its original cost minus accumulated depreciation.
the actions of a startup to minimize expenses and build cash flow, thereby reducing or eliminating the need for outside investors.
a type of IOU issued by companies or institutions. They generally have a fixed interest rate and maturity value, so they're very low risk - much less risky than buying equity - but their returns are accordingly low.
see Basis point.
temporary funding that will eventually be replaced by permanent capital from equity investors or debt lenders. In venture capital, a bridge is usually a short term note (6 to 12 months) that converts to preferred stock. Typically, the bridge lender has the right to convert the note to preferred stock at a price that is a 20% to 25% discount from the price of the preferred stock in the next financing round. See Mezzanine and Wipeout bridge.
Broad-based weighted average anti-dilution
A weighted average anti-dilution method adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A's preferred stock is repriced to a weighted average of investor A's price and investor B's price. A broad-based anti-dilution method uses all common stock outstanding on a fully diluted basis (including all convertible securities, warrants and options) in the denominator of the formula for determining the new weighted average price. See Narrow-based weighted average anti-dilution.
a payment of all principal due at a time specified by a bank or a bond issuer.
the rate at which a startup with little or no revenue uses available cash to cover expenses. Usually expressed on a monthly or weekly basis.
to receive government capital in the form of debt or equity in order to use in private equity investing.
Business Development Company (BDC)
a publicly traded company that invests in private companies and is required by law to provide meaningful support and assistance to its portfolio companies.
a document that describes a new concept for a business opportunity. A business plan typically includes the following sections: executive summary, market need, solution, technology, competition, marketing, management, operations, exit strategy, and financials (including cash flow projections). For most venture capital funds fewer than 10 of every 100 business plans received eventually receive funding.
Buy-in management buyout (BIMBO)
A BIMBO enables a company to re-shuffle its allocation of share capital to bring about a change in management. Internally, a group of managers will acquire enough share capital to 'buy out' the company from within. An outside team of managers will simultaneously 'buy in' to the company management. Both parties may require financial assistance from venture capitalists in order to achieve this end.
a sector of the private equity industry. Also, the purchase of a controlling interest of a company by an outside investor (in a leveraged buyout) or a management team (in a management buyout).
a contract that sets forth the conditions under which a shareholder must first offer his or her shares for sale to the other shareholders before being allowed to sell to entities outside the company.
an ownership structure that allows any number of individuals or companies to own shares. A C corporation is a stand-alone legal entity so it offers some protection to its owners, managers and investors from liability resulting from its actions.
when a bond issuer has the right to retire part or all of a bond issuance at a specific price.
the premium above par value that an issuer is willing to pay as part of the redemption of a bond issue prior to maturity.
the price an issuer agrees to pay to bondholders to redeem all or part of a bond issuance.
a provision in the terms of a bond specifying the period of time during which the bond cannot be called by the issuer.
Capital Asset Pricing Model (CAPM)
a method of estimating the cost of equity capital of a company. The cost of equity capital is equal to the return of a risk-free investment plus a premium that reflects the risk of the company's equity.
when a private equity fund manager (usually a "general partner" in a partnership) requests that an investor in the fund (a "limited partner") provide additional capital. Usually a limited partner will agree to a maximum investment amount and the general partner will make a series of capital calls over time to the limited partner as opportunities arise to finance startups and buyouts.
a tax classification of investment earnings resulting from the purchase and sale of assets. Typically, an investor prefers that investment earnings be classified as long term capital gains (held for a year or longer), which are taxed at a lower rate than ordinary income.
the difficulty faced by some entrepreneurs in trying to raise between $2 million and $5 million. Friends, family and angel investors are typically good sources for financing rounds of less than $2 million, while many venture capital funds have become so large that they are only interested in investing amounts greater than $5 million.
a description of stock that applies when there is only one class of shares. This class is known as "common stock".
a table showing the owners of a company's shares and their ownership percentages as well as the debt holders. It also lists the forms of ownership, such as common stock, preferred stock, warrants, options, senior debt, and subordinated debt.
Capped participating preferred stock
preferred stock whose participating feature is limited so that an investor cannot receive more than a specified amount. See Participating preferred stock.
the share in the capital gains of a venture capital fund which is allocated to the General Partner. Typically, a fund must return the capital given to it by limited partners plus any preferential rate of return before the general partner can share in the profits of the fund. The general partner will typically receive a 20% carried interest, although some successful firms receive 25%-30%. Also known as "carry" or "promote."
a clause in the agreement between the general partner and the limited partners of a private equity fund. Once the limited partners have received a certain portion of their expected return, the general partner can then receive a majority of profits until the previously agreed upon profit split is reached.
Change of control bonus
a bonus of cash or stock given by private equity investors to members of a management group if they successfully negotiate a sale of the company for a price greater than a specified amount.
a clause in the agreement between the general partner and the limited partners of a private equity fund. The clawback gives limited partners the right to reclaim a portion of disbursements to a general partner for profitable investments based on significant losses from later investments in a portfolio.
the conclusion of a financing round whereby all necessary legal documents are signed and capital has been transferred.
the act of investing by two or more entities in the same target company, usually involving a leveraged buyout transaction.
the direct investment by a limited partner alongside a general partner in a portfolio company.
hard assets of the borrower, such as real estate or equipment, for which a lender has a legal interest until a loan obligation is fully paid off.
an obligation, typically the maximum amount that a limited partner agrees to invest in a fund. See Capital call.
a type of security representing ownership rights in a company. Usually, company founders, management and employees own common stock while investors own preferred stock. In the event of a liquidation of the company, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common stockholders. See Preferred stock.
a publicly traded company with similar characteristics to a private company that is being valued. For example, a telecommunications equipment manufacturer whose market value is 2 times revenues can be used to estimate the value of a similar and relatively new company with a new product in the same industry. See Liquidity discount.
the authority of an individual or entity that owns more than 50% of equity in a company or owns the largest block of shares compared to other shareholders.
the right of an investor or lender to force a company to replace the investor's preferred shares or the lender's debt with common shares at a preset conversion ratio. A conversion feature was first used in railroad bonds in the 1800's.
a loan which allows the lender to exchange the debt for common shares in a company at a preset conversion ratio. Also known as a "convertible note."
Convertible preferred stock
a type of stock that gives an owner the right to convert to common shares of stock. Usually, preferred stock has certain rights that common stock doesn't have, such as decision-making management control, a promised return on investment (dividend), or senior priority in receiving proceeds from a sale or liquidation of the company. Typically, convertible preferred stock automatically converts to common stock if the company makes an initial public offering (IPO). Convertible preferred is the most common tool for private equity funds to invest in companies.
a security that gives its owner the right to exchange the security for common shares in a company at a preset conversion ratio. The security is typically preferred stock, warrants or debt.
a contractual right of an investor to sell some of the investor's stock along with the founder's or majority shareholder's stock if either the founder or majority shareholder elects to sell stock to a third-party. Also known as Tag-along right.
Cost of capital
see Weighted average cost of capital.
Cost of revenue
the expenses generated by the core operations of a company.
a legal promise to do or not do a certain thing. For example, in a financing arrangement, company management may agree to a negative covenant, whereby it promises not to incur additional debt. The penalties for violation of a covenant may vary from repairing the mistake to losing control of the company.
describes a company's ability to pay debt from cash flow or profits. Typical measures are EBITDA/Interest, (EBITDA minus Capital Expenditures)/Interest, and EBIT/Interest.
Cram down round
a financing event upon which new investors with substantial capital are able to demand and receive contractual terms that effectively cause the issuance of sufficient new shares by the startup company to significantly reduce ("dilute") the ownership percentage of previous investors.
the owner of preferred stock with cumulative dividends has the right to receive accrued (previously unpaid) dividends in full before dividends are paid to any other classes of stock.
the ratio of current assets to current liabilities.
a specific location where potential buyers / investors can review confidential information about a target company. This information may include detailed financial statements, client contracts, intellectual property, property leases, and compensation agreements.
a measure of the number of potential investments that a fund reviews in any given period.
Debt service ratio
the ratio of a required loan payment amount ("debt service") to available cash flow earned during a specific period. Typically lenders insist that a company maintain a certain debt service ratio or else risk penalties such as having to pay off the loan immediately.
a company's failure to comply with the terms and conditions of a financing arrangement.
Defined benefit plan
a company retirement plan in which the benefits are typically based on an employee's salary and number of years worked. Fixed benefits are paid after the employee retires. The employer bears the investment risk and is committed to providing the benefits to the employee. Defined benefit plan managers can invest in private equity funds.
Defined contribution plan
a company retirement plan in which the employee elects to contribute some portion of his or her salary into a retirement plan, such as a 401(k) or 403(b). The employer may also contribute to the employee's plan. With this type of plan, the employee bears the investment risk. The benefits depend solely on the amount of money made from investing the employee's contributions. Defined contribution plan capital cannot be invested in private equity funds.
a type of registration right. Demand rights give an investor the right to force a startup to register its shares with the SEC and prepare for a public sale of stock (IPO).
the reduction in the ownership percentage of current investors, founders and employees caused by the issuance of new shares to new investors.
see Anti-dilution and Ratchet.
see Cost of revenue.
an investment by a fund in a company.
the interest rate used to determine the present value of a series of future cash flows.
Discounted cash flow (DCF)
a valuation methodology whereby the present value of all future cash flows expected from a company is calculated.
the bonds of a company that is either in or approaching bankruptcy. Some private equity funds specialize in purchasing such debt at deep discounts with the expectation of exerting influence in the restructuring of the company and then selling the debt once the company has meaningfully recovered.
the transfer of cash or securities to a limited partner resulting from the sale, liquidation or IPO of one or more portfolio companies in which a general partner chose to invest.
payments made by a company to the owners of certain securities. Typically, dividends are paid quarterly, by approval of the board of directors, to owners of preferred stock.
a round of financing whereby the valuation of the company is lower than the value determined by investors in an earlier round.
the contractual right of an investor in a company to force all other investors to agree to a specific action, such as the sale of the company.
an estimate of the gradual transfer of committed investment funds from the limited partners of a private equity fund to the general partners.
a venture capitalist that only appears during board meetings of a portfolio company and rarely offers advice to management.
the investigatory process performed by investors to assess the viability of a potential investment and the accuracy of the information provided by the target company.
Due diligence checklist
a method of conducting an IPO whereby newly issued shares of stock are committed to the highest bidder, then, if any shares remain, to the next highest bidder, and so on until all the shares are committed. Note that the price per share paid by all buyers is the price commitment of the buyer of the last share.
the state of a company after the seed (formation) stage but before middle stage (generating revenues). Typically, a company in early stage will have a core management team and a proven concept or product, but no positive cash flow.
an arrangement in which sellers of a business receive additional future payments, usually based on financial performance metrics such as revenue or net income.
Earnings before interest and taxes (EBIT)
a measurement of the operating profit of a company. One possible valuation methodology is based on a comparison of private and public companies' value as a multiple of EBIT.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
a measurement of the cash flow of a company. One possible valuation methodology is based on a comparison of private and public companies' value as a multiple of EBITDA.
a concise presentation, lasting only a few minutes (an elevator ride), by an entrepreneur to a potential investor about an investment opportunity.
Employee Stock Ownership Program (ESOP)
a plan established by a company to reserve shares for employees.
Enterprise Value (EV)
the sum of the market values of the common stock and long term debt of a company, minus excess cash.
an individual who starts his or her own business.
the application of innovative leadership to limited resources in order to create exceptional value.
the ownership structure of a company represented by common shares, preferred shares or unit interests. Equity = Assets
see Employee Stock Ownership Program.
a fund that reinvests its profits in order to ensure the availability of capital for future investments.
the plan for generating profits for owners and investors of a company. Typically, the options are to merge, be acquired or make an initial public offering (IPO). An alternative is to recapitalize (re-leverage the company and then pay dividends to shareholders).
the stage of a company characterized by a complete management team and a substantial increase in revenues.
a financial reporting principle for valuing assets and liabilities, for example, portfolio companies in venture capital fund portfolios. This has received much recent attention as the Financial Accounting Standards Board (FASB) has issued definitive guidance (FAS 157) on this long standing principle.
a letter issued by an investment bank that charges a fee to assess the fairness of a negotiated price for a merger or acquisition.
a commitment by a syndicate of investment banks to purchase all the shares available for sale in a public offering of a company. The shares will then be resold to investors by the syndicate.
the right of a privately owned company to purchase any shares that employees would like to sell.
the act of selling shares immediately after an initial public offering.
a person who participates in the creation of a company. Typically, founders manage the company until it has enough capital to hire professional managers.
nominally priced common stock issued to founders, officers, employees, directors, and consultants.
Free cash flow to equity (FCFE)
the cash flow available after operating expenses, interest payments on debt, taxes, net principal repayments, preferred stock dividends, reinvestment needs and changes in working capital. In a discounted cash flow model to determine the value of the equity of a firm using FCFE, the discount rate used is the cost of equity.
Free cash flow to the firm (FCFF)
the operating cash flow available after operating expenses, taxes, reinvestment needs and changes in working capital, but before any interest payments on debt are made. In a discounted cash flow model to determine the enterprise value of a firm using FCFF, the discount rate used is the weighted average cost of capital (WACC).
Friends and family financing
capital provided by the friends and family of founders of an early stage company. Founders should be careful not to create an ownership structure that may hinder the participation of professional investors once the company begins to achieve success.
an anti-dilution protection mechanism whereby the price per share of the preferred stock of investor A is adjusted downward due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A's preferred stock is repriced to match the price of investor B's preferred stock. Usually as a result of the implementation of a ratchet, company management and employees who own a fixed amount of common shares suffer significant dilution. See Narrow-based weighted average anti-dilution and Broad-based weighted average anti-dilution.
Fully diluted basis
a methodology for calculating any per share ratios whereby the denominator is the total number of shares issued by the company on the assumption that all warrants and options are exercised and preferred stock.
a fund created to invest in private equity funds. Typically, individual investors and relatively small institutional investors participate in a fund-of-funds to minimize their portfolio management efforts.
intermediaries which endowments, pension funds and other institutional investors use as advisors regarding private equity investments.
General partner (GP)
a class of partner in a partnership. The general partner retains liability for the actions of the partnership. In the private equity world, the GP is the fund manager while the limited partners (LPs) are the institutional and high net worth investors in the partnership. The GP earns a management fee and a percentage of profits (see Carried interest).
when a public company chooses to pay off all public investors, delist from all stock exchanges, and become owned by management, employees, and select private investors.
financial incentives that discourage founders and / or important employees from leaving a company before a predetermined date or important milestone.
see General partner.
an adjustment of an option pool for management and employees of a company which increases the number of shares available over time. This usually occurs after a financing round whereby one or more investors receive a relatively large percentage of the company. Without a grossing up, managers and employees would suffer the financial and emotional consequences of dilution, thereby potentially affecting the overall performance of the company.
the state of a company when it has received one or more rounds of financing and is generating revenue from its product or service. Also known as "middle stage."
a law requiring entities that acquire certain amounts of stock or assets of a company to inform the Federal Trade Commission and the Department of Justice and to observe a waiting period before completing the transaction.
to generate cash or stock from the sale or IPO of companies in a private equity portfolio of investments.
an investment fund that has the ability to use leverage, take short positions in securities, or use a variety of derivative instruments in order to achieve a return that is relatively less correlated to the performance of typical indices (such as the S&P 500) than traditional long-only funds. Hedge fund managers are typically compensated based on assets under management as well as fund performance.
High yield debt
debt issued via public offering or public placement (Rule 144A) that is rated below investment grade by S&P or Moody's. This means that the debt is rated below the top four rating categories (i.e. S&P BB+, Moody's Ba2 or below). The lower rating is indicative of higher risk of default, and therefore the debt carries a higher coupon or yield than investment grade debt. Also referred to as Junk bonds or Sub-investment grade debt.
the general shape and form of a chart showing revenue, customers, cash or some other financial or operational measure that increases dramatically at some point in the future. Entrepreneurs often develop business plans with hockey stick charts to impress potential investors.
amount of time an investment remains in a portfolio.
stock in an initial public offering that is in high demand.
capital from investors that have no tolerance for lack of results by the investment manager and move quickly to withdraw at the first sign of trouble.
a minimum rate of return required before an investor will make an investment.
the process by which a business receives a state charter, allowing it to become a corporation. Many corporations choose Delaware because its laws are business-friendly and up to date.
a company or facility designed to host startup companies. Incubators help startups grow while controlling costs by offering networks of contacts and shared backoffice resources.
the terms and conditions between a bond issuer and bond buyers.
Initial public offering (IPO)
the first offering of stock by a company to the public. New public offerings must be registered with the Securities and Exchange Commission. An IPO is one of the methods that a startup that has achieved significant success can use to raise additional capital for further growth. See Qualified IPO.
a distribution to limited partners of a private equity fund that is in the form of publicly trades shares rather than cash.
a round of financing in which the investors are the same investors as the previous round. An inside round raises liability issues since the valuation of the company has no third party verification in the form of an outside investor. In addition, the terms of the inside round may be considered self-dealing if they are onerous to any set of shareholders or if the investors give themselves additional preferential rights.
professional entities that invest capital on behalf of companies or individuals. Examples are: pension plans, insurance companies and university endowments.
often prefer to invest in private equity funds that demonstrate consistent results over time, placing in the upper quartile of the investment results for all funds.
Intellectual property (IP)
knowledge, techniques, writings and images that are intangible but often protected by law via patents, copyrights, and trademarks.
Interest coverage ratio
earnings before interest and taxes (EBIT) divided by interest expense. This is a key ratio used by lenders to assess the ability of a company to produce sufficient cash to pay its debt obligation.
Internal rate of return (IRR)
the interest rate at which a certain amount of capital today would have to be invested in order to grow to a specific value at a specific time in the future.
that underwrite new stock issues attempt to allocate shares to new investors that indicate they will retain the shares for several months. Often management and venture investors are prohibited from selling IPO shares until a "lock-up period" (usually 6 to 12 months) has expired.
Investment thesis / Investment philosophy
the fundamental ideas which determine the types of investments that an investment fund will choose in order to achieve its financial goals.
see Initial public offering.
see Internal rate of return.Issuer
the company that chooses to distribute a portion of its stock to the public.
a concept that during the first few years of a private equity fund, cash flow or returns are negative due to investments, losses, and expenses, but as investments produce results the cash flow or returns trend upward. A graph of cash flow or returns versus time would then resemble the letter "J".
a loan that has a lower priority than a senior loan in case of a liquidation of the asset or borrowing company. Also known as "subordinated debt."
see High Yield Debt.
see The London Interbank Offered Rate.
the state of a company that has proven its concept, achieved significant revenues compared to its competition, and is approaching cash flow break even or positive net income. Typically, a later stage company is about 6 to 12 months away from a liquidity event such as an IPO or buyout. The rate of return for venture capitalists that invest in later stage, less risky ventures is lower than in earlier stage ventures.
see Leveraged buyout.
the venture capital investor that makes the largest investment in a financing round and manages the documentation and closing of that round. The lead investor sets the price per share of the financing round, thereby determining the valuation of the company.
Letter of intent
a document confirming the intent of an investor to participate in a round of financing for a company. By signing this document, the subject company agrees to begin the legal and due diligence process prior to the closing of the transaction. Also known as a "Term Sheet".
the use of debt to acquire assets, build operations and increase revenues. By using debt, a company is attempting to achieve results faster than if it only used its cash available from pre-leverage operations. The risk is that the increase in assets and revenues does not generate sufficient net income and cash flow to pay the interest costs of the debt.
measurements of a company's debt as a multiple of cash flow. Typical leverage ratios include Total Debt / EBITDA, Total Debt / (EBITDA minus Capital Expenditures), and Senior Debt / EBITDA.
Leveraged buyout (LBO)
the purchase of a company or a business unit of a company by an outside investor using mostly borrowed capital.
the reorganization of a company's capital structure resulting in more debt added to the balance sheet. Private equity funds can recapitalize a portfolio company and then direct the company to issue a one-time dividend to equity investors. This is often done when the company is performing well financially and the debt markets are expanding.
a contract in which a patent owner grants to a company the right to make, use or sell an invention under certain circumstances and for compensation.
Limited liability company (LLC)
an ownership structure designed to limit the founders' losses to the amount of their investment. An LLC does not pay taxes, rather its owners pay taxes on their proportion of the LLC profits at their individual tax rates.
Limited partner (LP)
an investor in a limited partnership. The general partner is liable for the actions of the partnership while the limited partners are generally protected from legal actions and any losses beyond their original investment. The limited partner receives income, capital gains and tax benefits.
a legal entity composed of a general partner and various limited partners. The general partner manages the investments and is liable for the actions of the partnership while the limited partners are generally protected from legal actions and any losses beyond their original investment. The general partner receives a management fee and a percentage of profits (see Carried interest), while the limited partners receive income, capital gains and tax benefits.
the sale of a company. This may occur in the context of an acquisition by a larger company or in the context of selling off all assets prior to cessation of operations (Chapter 7 bankruptcy). In a liquidation, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common stockholders.
the contractual right of an investor to priority in receiving the proceeds from the liquidation of a company. For example, a venture capital investor with a "2x liquidation preference" has the right to receive two times its original investment upon liquidation.
a decrease in the value of a private company compared to the value of a similar but publicly traded company. Since an investor in a private company cannot readily sell his or her investment, the shares in the private company must be valued less than a comparable public company.
a transaction whereby owners of a significant portion of the shares of a private company sell their shares in exchange for cash or shares in another, usually larger company. For example, an IPO is a liquidity event.
investors, management and employees often agree not to sell their shares for a specific time period after an IPO, usually 6 to 12 months. By avoiding large sales of its stock, the company has time to build interest among potential buyers of its shares.
London Interbank Offered Rate (L.I.B.O.R.)
the average rate charged by large banks in London for loans to each other. LIBOR is a relatively volatile rate and is typically quoted in maturities of one month, three months, six months and one year.
see Limited partner.
Management buyout (MBO)
a leveraged buyout controlled by the members of the management team of a company or a division. Often an MBO is conducted in partnership with a buyout fund.
a fee charged to the limited partners in a fund by the general partner. Management fees in a private equity fund usually range from 0.75% to 3% of capital under management, depending on the type and size of fund. For venture capital funds, 2% is typical.
the rights often required by a venture capitalist as part of the agreement to invest in a company. The venture capitalist has the right to consult with management on key operational issues, attend board meetings and review information about the company's financial situation.
the value of a publicly traded company as determined by multiplying the number of shares outstanding by the current price per share.
see Management buyout.
a layer of financing that has intermediate priority (seniority) in the capital structure of a company. For example, mezzanine debt has lower priority than senior debt but usually has a higher interest rate and often includes warrants. In venture capital, a mezzanine round is generally the round of financing that is designed to help a company have enough resources to reach an IPO. See Bridge financing.
the state of a company when it has received one or more rounds of financing and is generating revenue from its product or service. Also known as "growth stage."
operational or financial goals of a company that are often used to determine whether a company will receive additional financing or whether management will receive additional compensation.
a valuation methodology that compares public and private companies in terms of a ratio of value to an operations figure such as revenue or net income. For example, if several publicly traded computer hardware companies are valued at approximately 2 times revenues, then it is reasonable to assume that a startup computer hardware company that is growing fast has the potential to achieve a valuation of 2 times its revenues. Before the startup issues its IPO, it will likely be valued at less than 2 times revenue because of the lack of liquidity of its shares. See Liquidity discount.
Narrow-based weighted average ratchet
a type of anti-dilution mechanism. A weighted average ratchet adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A's preferred stock is repriced to a weighed average of investor A's price and investor B's price. A narrow-based ratchet uses only common stock outstanding in the denominator of the formula for determining the new weighted average price.
see Non-disclosure agreement.
Net operating income (NOI)
a measure of cash flow that excludes the effects of financing decisions. NOI is calculated as earnings before interest and taxes multiplied by one minus the tax rate. Also known as profit after taxes (NOPAT).
an agreement often signed by employees and management whereby they agree not to work for competitor companies or form a new competitor company within a certain time period after termination of employment.
dividends that are payable to owners of preferred stock at a specific point in time only if there is sufficient cash flow available after all company expenses have been paid. If cash flow is insufficient, the owners of the preferred stock will not receive the dividends owed for that time period and will have to wait until the board of directors declares another set of dividends.
Non-disclosure agreement (NDA)
an agreement issued by entrepreneurs to protect the privacy of their ideas when disclosing those ideas to third parties.
an agreement often signed by employees and management whereby they agree not to interfere with the company's relationships with employees, clients, suppliers and sub-contractors within a certain time period after termination of employment.
an agreement often signed by employees and management whereby they agree not to solicit other employees of the company regarding job opportunities.
a section of an agreement to purchase a company whereby the seller agrees not to market the company to other potential buyers for a specific time period.
a legal document that provides details of an investment to potential investors. See Private placement memorandum.
see Original issue discount.
Operating cash flow
the cash flow produced from the operation of a business, not from investing activities (such as selling assets) or financing activities (such as issuing debt). Calculated as net operating income (NOI) plus depreciation.
the way a concept is presented. Sometimes entrepreneurs' presentations are strong on optics but weak in content.
a group of options set aside for long term, phased compensation to management and employees.
see Stock options.
Original issue discount (OID)
a discount from par value of a bond or debt-like instrument. In structuring a private equity transaction, the use of a preferred stock with liquidation preference or other clauses that guarantee a fixed payment in the future can potentially create adverse tax consequences. The IRS views this cash flow stream as, in essence, a zero coupon bond upon which tax payments are due yearly based on "phantom income" imputed from the difference between the original investment and "guaranteed" eventual payout. Although complex, the solution is to include enough clauses in the investment agreements to create the possibility of a material change in the cash flows of owners of the preferred stock under different scenarios of events such as a buyout, dissolution or IPO.
a startup company that does not have a venture capitalist as an investor.
the total amount of common shares of a company, not including treasury stock, convertible preferred stock, warrants and options. Oversubscriptionwhen demand exceeds supply for shares of an IPO or a private placement.
Pari passua legal term referring to the equal treatment of two or more parties in an agreement. For example, a venture capitalist may agree to have registration rights that are pari passu with the other investors in a financing round.
the right of holders of certain preferred stock to receive dividends and participate in additional distributions of cash, stock or other assets. Participating preferred stock a unit of ownership composed of preferred stock and common stock. The preferred stock entitles the owner to receive a predetermined sum of cash (usually the original investment plus accrued dividends) if the company is sold or has an IPO. The common stock represents additional continued ownership in the company. Participating preferred stock has been characterized as "having your cake and eating it too."
a legal right to sue any person or company that attempts to use, manufacture or sell the patented product or process. Patents typically have a 20 year term.
Pay to play
a clause in a financing agreement whereby any investor that does not participate in a future round agrees to suffer significant dilution compared to other investors. The most onerous version of "pay to play" is automatic conversion to common shares, which in essence ends any preferential rights of an investor, such as the right to influence key management decisions.
see Price earnings ratio.
acronym for Private Equity Industry Guidelines Group, an ad hoc group of individuals and firms involved in the private equity industry for the purpose of establishing valuation and reporting guidelines.
rights of an investor to have his or her shares included in a registration of a startup's shares in preparation for an IPO.
see Private investment in public equities.
a company that specializes in finding institutional investors that are willing and able to invest in a private equity fund. Sometimes a private equity fund will hire a placement agent so the fund partners can focus on making and managing investments in companies rather than on raising capital.
a company that has received an investment from a private equity fund.
the valuation of a company including the capital provided by the current round of financing. For example, a venture capitalist may invest $5 million in a company valued at $2 million "pre-money" (before the investment was made). As a result, the startup will have a post-money valuation of $7 million.
see Private placement memorandum.
the rights of shareholders to maintain their percentage ownership of a company by buying shares sold by the company in future financing rounds.
seniority, usually with respect to dividends and proceeds from a sale or dissolution of a company.
a minimum return per annum that must be generated for limited partners of a private equity fund before the general partner can begin receiving a percentage of profits from investments.
a type of stock that has certain rights that common stock does not have. These special rights may include dividends, participation, liquidity preference, anti-dilution protection and veto provisions, among others. Private equity investors usually purchase preferred stock when they make investments in companies
. Pre-money valuation
the valuation of a company prior to the current round of financing. For example, a venture capitalist may invest $5 million in a company valued at $2 million pre-money. As a result, the startup will have a "post-money" valuation of $7 million.
Price earnings ratio (PE ratio)
the ratio of a public company's price per share and its net income after taxes on a per share basis.
shares sold by a corporation (not by individual shareholders).
equity investments in non-public companies, usually defined as being made up of venture capital funds and buyout funds. Real estate, oil and gas, and other such partnerships are sometimes included in the definition.
Private investment in public equities (PIPES)
investments by a private equity fund in a publicly traded company, usually at a discount and in the form of preferred stock.
the sale of a security directly to a limited number of institutional and qualified individual investors. If structured correctly, a private placement avoids registration with the Securities and Exchange Commission.
Private placement memorandum (PPM)
a document explaining the details of an investment to potential investors. For example, a private equity fund will issue a PPM when it is raising capital from institutional investors. Also, a startup may issue a PPM when it needs growth capital. Also known as "Offering Memorandum."
securities that are not registered with the Securities and Exchange Commission and do not trade on any exchanges. The price per share is negotiated between the buyer and the seller (the "issuer").
a formal document that gives sufficient detail about a business opportunity for a prospective investor to make a decision. A prospectus must disclose any material risks and be filed with the Securities and Exchange Commission.
Prudent man rule
a fundamental principle for professional money management which serves as a basis for the Prudent Investor Act. The principle is based on a statement by Judge Samuel Putnum in 1830: "Those with the responsibility to invest money for others should act with prudence, discretion, intelligence and regard for the safety of capital as well as income." In the 1970s a favorable interpretation of this rule enabled pension fund managers to invest in venture capital for the first time.
a merger accounting treatment whereby a buyer purchases the assets (and liability obligations) of a company at their market price and then records the difference between the purchase price and the book value of the assets as goodwill. This goodwill need not be amortized but must be valued annually and any decreases or increases in value must be reflected in the buyer's financial statements.
a public offering of securities valued at or above a total amount specified in a financing agreement. This amount is usually specified to be sufficiently large to guarantee that the IPO shares will trade in a major exchange (NASDAQ or New York Stock Exchange). Usually upon a qualified IPO preferred stock is forced to convert to common stock.
a mechanism to prevent dilution. An anti-dilution clause is a contract clause that protects an investor from a reduction in percentage ownership in a company due to the future issuance by the company of additional shares to other entities.
the ratio of cumulative distributions to paid-in capital. The realization ratio is used as a measure of the distributions from investment results of a private equity partnership compared to the capital under management.
the reorganization of a company's capital structure.
a preliminary prospectus filed with the Securities and Exchange Commission and containing the details of an IPO offering. The name refers to the disclosure warning printed in red letters on the cover of each preliminary prospectus advising potential investors of the risks involved.
preferred stock that can be redeemed by the owner (usually a venture capital investor) in exchange for a specific sum of money.
the right of an investor to force the startup company to buy back the shares issued as a result of the investment. In effect, the investor has the right to take back his/her investment and may even negotiate a right to receive an additional sum in excess of the original investment.
the process whereby shares of a company are registered with the Securities and Exchange Commission under the Securities Act of 1933 in preparation for a sale of the shares to the public.
the rights of an investor in a startup regarding the registration of a portion of the startup's shares for sale to the public. Piggyback rights give the shareholders the right to have their shares included in a registration. Demand rights give the shareholders the option to force management to register the company's shares for a public offering. Often, registration rights are hotly negotiated among venture capitalists in multiple rounds of financing.
an SEC regulation that governs private placements. Private placements are investment offerings for institutional and accredited individual investors but not for the general public. There is an exception that 35 non-accredited investors can participate.
shares that cannot be traded in the public markets.
Return on investment (ROI)
the proceeds from an investment, during a specific time period, calculated as a percentage of the original investment. Also, net profit after taxes divided by average total assets
Right of first refusal
a contractual right to participate in a transaction. For example, a venture capitalist may participate in a first round of investment in a startup and request a right of first refusal in any following rounds of investment.
Rights of co-sale with founders
a clause in venture capital investment agreements that allows the VC fund to sell shares at the same time that the founders of a startup chose to sell.
an offering of stock to current shareholders that entitles them to purchase the new issue, usually at a discount.
a term used in finance theory to describe the return from investing in a riskless security. In practice, this is often taken to be the return on US Treasury Bills.
presentations made in several cities to potential investors and other interested parties. For example, a company will often make a road show to generate interest among institutional investors prior to its IPO.
see Return on investment.
the purchase of relatively smaller companies in a sector by a rapidly growing company in the same sector. The strategy is to create economies of scale. For example, the movie theater industry underwent significant consolidation in the 1960's and 1970's.
a financing event usually involving several private equity investors.
payments made to patent or copyright owners in exchange for the use of their intellectual property.
a rule of the Securities and Exchange Commission that specifies the conditions under which the holder of shares acquired in a private transaction may sell those shares in the public markets.
an ownership structure that limits its number of owners to 100. An S corporation does not pay taxes, rather its owners pay taxes on their proportion of the corporation's profits at their individual tax rates.
see Small Business Investment Company.
a characteristic of a new business concept that entails the growth of sales and revenues with a much slower growth of organizational complexity and expenses. Venture capitalists look for scalability in the startups they select to finance.
a schedule for phased decreases in management fees for general partners in a limited partnership as the fund reduces its investment activities toward the end of its term.
the process of a company growing quickly while maintaining operational and financial controls in place. Also, a schedule for phased increases in management fees for general partners in a limited partnership as the fund increases its investment activities over time.
an investment fund whereby one or two individuals raise sufficient capital to pay for their salary and expenses for a one to two year period in searching for a target company to acquire. Once the target is identified and a purchase agreement is signed, the individuals seek another round of funding from current and additional investors in order to purchase the target (usually using leverage).
see Securities and Exchange Commission.
a market for the sale of limited partnership interests in private equity funds. Sometimes limited partners chose to sell their interest in a partnership, typically to raise cash or because they cannot meet their obligation to invest more capital according to the takedown schedule. Certain investment companies specialize in buying these partnership interests at a discount.
shares sold by a shareholder (not by the corporation).
debt that has seniority in case the borrowing company defaults or is dissolved and its assets sold to pay creditors. Securities and Exchange Commission (SEC) the regulatory body that enforces federal securities laws such as the Securities Act of 1933 and the Securities Exchange Act of 1934.
a document that represents an interest in a company. Shares of stock, notes and bonds are examples of securities.
investment provided by angels, friends and family to the founders of a startup in seed stage.
the state of a company when it has just been incorporated and its founders are developing their product or service.
a loan that has a higher priority in case of a liquidation of the asset or company.
Series A preferred stock
preferred stock issued by a fast growth company in exchange for capital from investors in the "A" round of financing. This preferred stock is usually convertible to common shares upon the IPO or sale of the company.
a method of calculating the risk-adjusted return of an investment. The Sharpe Ratio is calculated by subtracting the risk-free rate from the return on a specific investment for a time period (usually one year) and then dividing the resulting figure by the standard deviation of the historical (annual) returns for that investment. The higher the Sharpe Ratio, the better.
Small Business Investment Company (SBIC)
a company licensed by the Small
a division of an established company that becomes an independent entity. Also known as a spin-off.
a share of ownership in a corporation.
a right to purchase or sell a share of stock at a specific price within a specific period of time. Stock purchase options are commonly used as long term incentive compensation for employees and management of fast growth companies.
a relatively large corporation that agrees to invest in a young company in order to have access to a proprietary technology, product or service. By having this access, the corporation can potentially achieve its strategic goals.
a loan that has a lower priority than a senior loan in case of a liquidation of the asset or company. Also known as "junior debt".
ownership of shares in a company resulting from work rather than investment of capital.
a group of investors that agree to participate in a round of funding for a company. Alternatively, a syndicate can refer to a group of investment banks that agree to participate in the sale of stock to the public as part of an IPO.
the process of arranging a syndicate.
the right of a minority investor to receive the same benefits as a majority investor. Usually applies to a sale of securities by investors. Also known as
a schedule of the transfer of capital in phases in order to complete a commitment of funds. Typically, a takedown is used by a general partner of a private equity fund to plan the transfer of capital from the limited partners.
the transfer of control of a company.
an investment that returns 10 times the initial capital.
an offer to public shareholders of a company to purchase their shares.
a bank loan for a specific period of time, usually up to ten years in leveraged buyout structures.
a document confirming the intent of an investor to participate in a round of financing for a company. By signing this document, the subject company agrees to begin the legal and due diligence process prior to the closing of the transaction. Also known as "Letter of Intent".
something that is not generally known, is kept in secrecy and gives its owners a competitive business advantage.
a portion of a set of securities. Each tranche may have different rights or risk characteristics.
a process resulting in a substantial increase in a company's revenues, profits and reputation.
an expression referring to 2 times the original amount. For example, a preferred stock may have a "two x" liquidation preference, so in case of liquidation of the company, the preferred stock investor would receive twice his or her original investment.
Under water option
an option is said to be under water if the current fair market value of a stock is less than the option exercise price.
an investment bank that chooses to be responsible for the process of selling new securities to the public. An underwriter usually chooses to work with a syndicate of investment banks in order to maximize the distribution of the securities.
debt which does not have any priority in case of dissolution of the company and sale of its assets.
a segment of the private equity industry which focuses on investing in new companies with high growth rates.
Venture capital method
a valuation method whereby an estimate of the future value of a company is discounted by a certain interest rate and adjusted for future anticipated dilution in order to determine the current value. Usually, discount rates for the venture capital method are considerably higher than public stock return rates, representing the fact that venture capitalists must achieve significant returns on investment in order to compensate for the risks they take in funding unproven companies.
a schedule by which employees gain ownership over time of a previously agreed upon amount of retirement funding or stock options.
the year that a private equity fund stops accepting new investors and begins to make investments on behalf of those investors.
the rights of holders of preferred and common stock in a company to vote on certain acts affecting the company. These matters may include payment of dividends, issuance of a new class of stock, merger or liquidation.
a security which gives the holder the right to purchase shares in a company at a pre-determined price. A warrant is a long term option, usually valid for several years or indefinitely. Typically, warrants are issued concurrently with preferred stocks or bonds in order to increase the appeal of the stocks or bonds to potential investors.
a financing round whereby previous investors, the founders and management suffer significant dilution. Usually as a result of a washout round, the new investor gains majority ownership and control of the company.
Weighted average anti-dilution
an anti-dilution protection mechanism whereby the conversion rate of preferred stock is adjusted in order to reduce an investor's loss due to an increase in the number of shares in a company. Without anti-dilution protection, an investor would suffer from a reduction of his or her percentage ownership. Usually as a result of the implementation of a weighted average anti-dilution, company management and employees who own a fixed amount of common shares suffer significant dilution, but not as badly as in the case of a full ratchet.
Weighted average cost of capital (WACC)
the average of the cost of equity and the after-tax cost of debt. This average is determined using weight factors based on the ratio of equity to debt plus equity and the ratio of debt to debt plus equity.
a short term financing that has onerous features whereby if the company does not secure additional long term financing within a certain time frame, the bridge investor gains ownership control of the company. See Bridge financing.
see Washout round.
a decrease in the reported value of an asset or a company.
a decrease in the reported value of an asset or a company to zero.
an increase in the reported value of an asset or a company.
a company that has received capital from investors but has only generated sufficient revenues and cash flow to maintain its operations without significant growth. Typically, a venture capitalist has to make a difficult decision as to whether to kill off a zombie or continue to invest funds in the hopes that the zombie will become a winner.