Terminology

This terminology list is not intended to be legal advice, it is intended for general informational purposes and is in alphabetical order.

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Accredited Investors

Accredited investors are those who have $1M in assets, exclusive of their residence, $200k annual income or $300K combined household income.

Audit

An audit is an official inspection of an individual’s or organization’s accounts, typically by an independent body that follows generally accepted accounting principles (GAAP). Under the JOBS Act, companies that are raising over $500,000 must have audited financial statements.

Broker-Dealer

Broker-dealers are considered intermediaries within the meaning of the JOBS Act. A broker-dealer is a license granted by the Securities and Exchange Commission that entitles the holder of the license to buy and sell securities for its clients’ accounts. Under the JOBS Act, all businesses offering shares to investors must list their project through a registered Broker-Dealer.

Business Plan

A business plan is a comprehensive summary of a business and details the plan for growth and profitability. A business plan should include a detailed analysis of market segment, sales and marketing strategy, strategic growth plan, projected headcount, competition and a corresponding financial plan.

Campaign Plan

A campaign plan outlines a strategy to present and communicate a company’s offering to investors and potential consumers interested in staying engaged.

Carried Interest

Carried interest is how hedge funds and venture capitalists are compensated. Generally known as a share of the profits on the increased value of an investment.

Closely Held Company

A closely held company is one in which a small amount of investors, quite often the people who founded the company, family members, or the current management team, own a majority of the outstanding stock. Laws in many states limit the number of owners to 35 or 75 people.

Closing Documents

Upon the close of a fundraising round, startups need to have some specific documents ready for their investors including a subscription agreement which provides detailed terms of the investment.

Conversion Discount

A conversion discount grants initial investors the right to convert the amount of the loan, plus interest, at a reduced price or a discounted percentage to the purchase price paid by the Series A investors.

Convertible Note

Convertible notes are often used by angel investors who want to fund businesses without establishing a specific valuation of the company in which they are investing. When an investor purchases or buys equity in a startup, the purchase price of the equity signifies a company valuation. Some early stage investors may want to avoid placing a value on the company because this will affect the terms under which later-stage investors will invest in the company.

Convertible notes are structured as loans at the time the investment is made. The outstanding balance of the loan is automatically converted to equity when a later round of funding occurs or a new equity investor appears. These terms are governed by the terms set by the later-stage equity investor. A convertible note is an unsecured loan that converts to stock at some point in the future. Convertible notes are currently the most popular form of seed-stage startup investing because of their history, simplicity, and affordability. Convertible notes are also helpful and useful because they postpone the difficult task of figuring out how much the startup is worth.

If the startup doesn’t raise another round of funding the note becomes due at the maturity date, typically in 18-24 months. Moreover, convertible notes rarely are repaid in cash – instead, the note usually converts to equity at a pre-set target price.

The discount and interest rates have a minor impact on future returns. The most important term to focus on – which can greatly impact the price of future shares – is the Valuation Cap. This is usually set depending on how much traction and popularity the startup has.

Corporate Structure

The organizational corporate structure is any affiliated entities, current capitalization and the founders who own the company. Strategy any previous related experience in the field provides evidence that the company is not disqualified from proceeding with its offering. The issuer company is responsible for providing clear disclosure of its financials, business plan, origins, operations, and its legal authority to engage in business activities.

Coworking

Coworking is a style of work that involves independent activities within a shared working environment, often an office or a converted warehouse. Entrepreneurs working at coworking facilities are usually not employed by the same organization and herein lies the main difference to that of a standard, structured office environment. Recent college graduates, small businesses, work-at-home professionals, independent contractors, and those who travel frequently work in relative isolation. Community, coffee and comradery are at the forefront as alliances, friendships and partnerships are not uncommon occurrences in coworking spaces.

Clearing House

A clearing house is a business that banks use to exchange checks and money, they also provide settlement services for securities transactions and loans.

Demonstrated Traction

Demonstrated traction includes any revenue, pre-sales, signed contracts, media coverage or awards a startup has generated prior to a raise.

Dilution

Dilution occurs when equity investments from investors make them part-owners in a company and the founders’ ownership percentage decreases.

Disclosure by Companies

Consistent with Title III of the JOBS Act, the proposed rules require companies conducting an equity crowdfunding or crowdinvesting offering to file certain information with the SEC and provide the information to investors and the relevant intermediary conducting the crowdfunding offering.

Discount Rate

The discount rate is a term in a Convertible Note or SAFE that gives the original investors a reduced price to that paid by the Series A investors.

Donation

Unlike Rewards-Based Crowdfunding or Equity Crowdfunding, a Donation is a contribution to a charitable campaign. Those who make true donations usually do not get anything in return.

Due Diligence

Due diligence is research conducted on a company before it is able to accept investments in order to determine its viability as an investment opportunity and any key risks associated with that company or its founders.

Equity Investor

An equity investor is someone, or a group of people, a fund or company who purchases equity stake in a company.

Escrow

The account where funds are held by a neutral third party pending a successful completion of a raise. The escrow is subsequently distributed in accordance with the escrow instructions and securities law regulations. This will include distribution of the success fee.

Executive Summary

An executive summary, sometimes referred to as a “teaser” is a brief high-level overview of a businesses’ overall activities, how their product works, and the strategic plan to develop the business. This is often the first part of the offering to a potential investor.

Exemptions

Securities laws are quite complex. Each state – as well as the SEC – highly regulates how equity or debt may be sold. To avoid the very expensive regulations public companies comply with, startups must qualify under one of the several federal exemptions from securities registration.

  1. Reg D, Rule 506(b) – Private Fundraising

  2. Reg D, Rule 506(c) – Public Fundraising

  3. 4(a)(6) – Regulation Crowdfunding

 

  1. Reg D, Rule 506(b) – Private Fundraising Companies using the Rule 506(b) exemption can raise an unlimited amount of money from accredited investors and a maximum of 35 unaccredited investors. Almost all startup investing was conducted this way until late 2013. Companies using Rule 506(b) must not advertise their fundraising.

  2. Reg D, Rule 506(c) – Public Fundraising This is a new exemption released by the SEC on September 23rd, 2013. Like Rule 506(c), startups using this exemption are permitted to raise an unlimited amount of capital from accredited investors. But, unlike 506(b), these startups are permitted to advertise their fundraising to the public. But there’s a downside. Startups using 506(c) must verify that all their investors actually are accredited. This may require the investor to provide a letter from their lawyer, or it can be as burdensome as requiring tax returns or bank statements.

  3. 4(a)(6) – Regulation Crowdfunding Created by the JOBS Act, Regulation Crowdfunding allows startups to raise up to $1 million per year from an unlimited number of investors. This exemption has not yet been implemented by the SEC. Investors are limited in the amount of capital they can invest in Regulation Crowdfunding startups per year. To calculate an investment limit, choose either the net income or net worth of the investor – whichever is higher. If the higher number is over $100,000, the investor is allowed to invest 10% of it each year. Otherwise the amount is 5%.

Financials

Investors expect to see documents including: projected headcount, ‘use of funds’ and 5 year financial projections while considering investment.

General Solicitation

Title II of the JOBS Act, implemented on September 23, 2013, involves the removal of the 80-year-old ban on general solicitation, a company’s ability to publicly advertise that it’s seeking investment. This gives startups a tremendous new flexibility in promoting their crowdfunding campaigns and extends their reach significantly. Startups must complete and file a Form D with the SEC at least 15 days before starting their general solicitation, and must file an amended Form D within 30 days of closing their fundraising round. Startups must also take reasonable steps to ensure their investors are accredited.

General Solicitation

Title II of the JOBS Act, implemented on September 23, 2013, involves the removal of the 80-year-old ban on general solicitation, a company’s ability to publicly advertise that it’s seeking investment. This gives startups a tremendous new flexibility in promoting their crowdfunding campaigns and extends their reach significantly. Startups must complete and file a Form D with the SEC at least 15 days before starting their general solicitation, and must file an amended Form D within 30 days of closing their fundraising round. Startups must also take reasonable steps to ensure their investors are accredited.

Growth Strategy

Growth strategy is the process by which a company seeks to win a larger market share even at the expense of short-term earnings.

Intellectual property

Intellectual property, or “IP” is a legal term that refers to creations made by individuals or groups of individuals. IP can include music, literature, discoveries, inventions, phrases, symbols, and designs. Intellectual property laws grant owners of intellectual property certain exclusive rights. Quite often investors want to know if a startup has any inherent IP.

Intermediary

An intermediary can be a firm or person such as a broker or consultant who acts as a mediator or a link between parties to a business deal, investment decision, negotiation, etc.

Interest Rate

Interest is charged by lenders as compensation for the loss of the asset’s use. The amount charged is expressed as a percentage of principal by a lender to a borrower for the use of assets. Interest rates are quite often noted on an annual basis, known as the annual percentage rate (APR). Interest is essentially a rental, or leasing charge to the borrower, for the use of the assets.

Intermediary

An intermediary can be a firm or person such as a broker or consultant who acts as a mediator or a link between parties to a business deal, investment decision, negotiation, etc.

JOBS Act

The “Jumpstart Our Business Startups Act” or JOBS Act creates new exemptions from previously existing Securities Laws; it is intended to encourage fund raising for small businesses in the United States and was passed into law on April 5, 2012. The JOBS Act is also sometimes used informally to refer to Titles II and III of the legislation, which are the two most importance pieces. Title III allows equity crowdfunding for the first time in generations. It provides a new exemption, subject to several conditions, from the requirement to register public offerings with the SEC for certain types of small offerings. Companies can raise up to $1,000,000 annually. The implementation of the JOBS Act is delegated to the SEC who are charged with preparing the Regulations to implement the new laws.

Minimum Viable Product

A minimum viable product or “MVP” is a new product released to the public with sufficient features to satisfy very early adopters. It is the first version of a product to hit the market. Quite often MVP’s consist of very basic functionality and, in time, grow to encompass more features.

Offering

The security documentation which provides the details including potential risks of an investment opportunity. An offering is sold by an intermediary on behalf of the issuer.

Pitch Deck

The pitch deck is usually a power point presentation, a more visual, concise adaptation of a company’s executive summary and business. The pitch deck can be a vital first document requested by investors and is oftentimes presented in person.

Platform

The integrated software and services used by a portal to effectively qualify and present businesses to investors. The platform facilitates the presentation, fulfillment, transactions and settlement of the offering.

Post-Money Valuation

The post-money valuation is the valuation of the company after an investment has been made. It is equal to the pre-money valuation plus the amount of the investment.

Pre-Money Valuation

A pre-money valuation is a term widely used in private equity or venture capital industries and it refers to the valuation of a company or asset prior to an investment or financing. If an investment adds cash to a company, the company’s valuation will change before and after the investment. The pre-money valuation refers to the company’s valuation before the investment occurs.

Priced Preferred Stock

Not long ago legal fees cost upwards of $50,000 to properly set up a stock financing. It has been uneconomical for companies to pay this amount unless venture capitalists invested in a Series A. Nowadays, some startups use open-sourced “priced round” documents to reduce the overall costs of a stock financing at the seed stage. For a non-lead investor investing a small amount, the most important terms to pay attention to are the Post-Money Valuation and the Pre-Money Valuation. This is generally what the company is considered to be worth, with it a percentage ownership can be calculated.

Regulation A+

Regulation A+ allows private companies to make exempt public offerings of up to $50 million of securities within a 12-month period, as required by the Jumpstart Our Business Startups Act (JOBS Act).

The rules establish two tiers of offerings under Regulation A: Tier 1 offerings of up to $20 million (up from $5 million previously) within a 12-month period and new Tier 2 offerings of up to $50 million within a 12-month period.

Highlights of the Final Rules

The final rules, often referred to as Regulation A+, would implement Title IV of the JOBS Act and provide for two tiers of offerings:

  • Tier 1, which would consist of securities offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer.
  • Tier 2, which would consist of securities offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

In addition to the limits on secondary sales by affiliates, the rules also limit sales by all selling security-holders to no more than 30 percent of a particular offering in the issuer’s initial Regulation A offering and subsequent Regulation A offerings for the first 12 months following the initial offering.

For offerings of up to $20 million, the issuer could elect whether to proceed under Tier 1 or Tier 2.  Both tiers would be subject to basic requirements as to issuer eligibility, disclosure, and other matters, drawn from the current provisions of Regulation A.  Both tiers would also permit companies to submit draft offering statements for non‑public review by Commission staff before filing, permit the continued use of solicitation materials after filing the offering statement, require the electronic filing of offering materials and otherwise align Regulation A with current practice for registered offerings.

Additional Tier 2 Requirements

In addition to these basic requirements, companies conducting Tier 2 offerings would be subject to other requirements, including:

  • A requirement to provide audited financial statements.
  • A requirement to file annual, semiannual and current event reports.
  • A limitation on the amount of securities non-accredited investors can purchase in a Tier 2 offering of no more than 10 percent of the greater of the investor’s annual income or net worth.

The staff would also conduct a study and submit a report to the Commission on the impact of both the Tier 1 and Tier 2 offerings on capital formation and investor protection no later than five years following the adoption of the amendments to Regulation A.

The Commission is exploring ways to further collaborate with state regulators, including a program for a representative of NASAA or a state securities regulator to work with the staff in the SEC’s Division of Corporation Finance in implementing these rules.

Eligibility

The exemption would be limited to companies organized in and with their principal place of business in the United States or Canada.  The exemption would not be available to companies that:

  • Are already SEC reporting companies and certain investment companies.
  • Have no specific business plan or purpose or have indicated their business plan is to engage in a merger or acquisition with an unidentified company.
  • Are seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights.
  • Have been subject to any order of the Commission under Exchange Act Section 12(j) entered within the past five years.
  • Have not filed ongoing reports required by the rules during the preceding two years.
  • Are disqualified under the “bad actor” disqualification rules.

The rules exempt securities in a Tier 2 offering from the mandatory registration requirements of Exchange Act Section 12(g) if the issuer meets all of the following conditions:

  • Engages services from a transfer agent registered with the Commission.
  • Remains subject to a Tier 2 reporting obligation.
  • Is current in its annual and semiannual reporting at fiscal year-end.
  • Has a public float of less than $75 million as of the last business day of its most recently completed semiannual period, or, in the absence of a public float, had annual revenues of less than $50 million as of its most recently completed fiscal year.

An issuer that exceeds the dollar and Section 12(g) registration thresholds would have a two-year transition period before it must register its class of securities, provided it timely files all of its ongoing reports required under Regulation A.

Preemption of Blue Sky Law

In light of the total package of investor protections included in amended Regulation A, the rules provide for the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers,” defined to be any person to whom securities are offered or sold under a Tier 2 offering.

Background

Under the Securities Act of 1933, when a company offers or sells securities to potential investors, it must either register the offer and sale or rely on an exemption from registration.  Regulation A is a longstanding exemption from registration that permits unregistered public offerings of up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by security-holders of the company.  In recent years, Regulation A offerings have been relatively rare in comparison to offerings conducted in reliance on other Securities Act exemptions or on a registered basis.

The JOBS Act amended the Securities Act to require the Commission to update and expand the Regulation A exemption.  In particular, the JOBS Act directed the Commission to:

  • Adopt rules that would allow offerings of up to $50 million of securities within a 12-month period.
  • Require companies conducting such offerings to file annual audited financial statements with the SEC.
  • Adopt additional requirements and conditions that the Commission determines necessary.

Seed Round

A seed round is the first significant money a startup receives, this can be from family, friends or one or many angel investors.

Series A

Series A is quite often the first investment by a venture capitalist. Series A financing can be provided in the form of preferred stock and may offer anti-dilution provisions in the event that further financing through preferred or common stock occurs in the future.

Startup Accelerator

Accelerators are for-profit programs that accept open-applications to join a class or coworking environment made up of small founding teams and individuals with ideas in different stages of development. In exchange for equity Accelerators are intended to provide coaching and small amounts of capital along with visiting mentors and business professionals joining in for training. The programs usually run 3 to 6 months. The startups work towards a “demo day” where they pitch to a group of investors and venture capitalists.

Term

A term can be a maturity date by which a company must either repay a note or create conversion by completing a Series A round.

Terms of the Offering

The issuer company describes in its offering terms any important facts relevant to the deal being offered and further identifies how it has reached its current valuation and how it plans to track and communicate with its investors.

Private Equity

Private equity is a term for large amounts of money raised from accredited individuals and institutions and then pooled in to a fund that, in turn, invests in a variety of business ventures. The fund is usually set up as a limited partnership with a private equity firm as the general partner and the investors as limited partners. Private equity firms charge fees for participating in the partnership and usually specialize in a particular type of investment.

Valuation Cap

The valuation cap is a term in a Convertible Note that puts a ceiling on a conversion price. It rewards the first investors more for the extra risk they took by investing early.

Regulation D

A Securities and Exchange Commission (SEC) regulation that governs private placement exemptions. Regulation D allows smaller companies to raise capital through the sale of equity or debt securities without having to register their securities with the SEC. There is a simple filing required that is far less onerous than a full public stock registration.

Securities

A Security is a financial asset, like a share of stock, bond or ownership in any other form, such as a percentage in a partnership or limited liability company. The SEC considers anything that is offered for value in exchange for money or an investment to be a security, and thus it requires registration or the application of some other securities exemption.

Valuation Cap

The valuation cap is a term in a Convertible Note that puts a ceiling on a conversion price. It rewards the first investors more for the extra risk they took by investing early.