Venture Capital and Mergers and Acquisitions Glossary

by Matt Storms

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Below is a glossary for venture capital and merger and acquisition transactions. Users are encouraged to submit additional words for inclusion and suggestions for improved definitions. Once updating starts, the most up to date version of the glossary will be maintained at this link: Current Venture Capital and Merger and Acquisition Glossary.

Accredited investor

A person or entity that meets certain requirements under the federal securities laws for investment purposes. For example, a natural person is an accredited investor if he or she has a net worth (with spouse) that exceeds $1 million at the time of the purchase of securities, or has income either individually that exceeds $200,000 in each of the two most recent years or jointly with spouse that exceeds $300,000 for the two most recent years.

Angel investor

A wealthy individual (accredited investor) who provides seed or early-stage financing from his or her own funds in return for equity. Angel investors sometimes provide industry knowledge and contacts and sometimes play a direct role on the board, but infrequently participate in management. Angels invest either as individuals or in groups.

Anti-dilution provisions

An adjustment mechanism for preferred stock, options, or convertible securities that provides the holder the right to receive additional securities in the event of a future financing in which securities are sold at a lower price than originally paid by the holder of the right. Typically, anti-dilution provisions come in two types: full ratchet and weighted average. There are typically exceptions for the adjustment mechanism that carve out situations such as the issuance of certain employee options or existing convertible securities.

Assignment of inventions agreement

An agreement that states who owns the rights to intellectual property that is developed. An assignment of inventions agreement typically makes clear that an entity owns the relevant intellectual property developed by its employees, contractors, and agents.

Blank check preferred stock

Unissued class of preferred stock of a company, the terms and conditions of which (such as liquidation, voting, dividend, and conversion rights) may be expressly determined by the company’s board of directors without further shareholder approval. An issuer will typically use blank check preferred stock to simplify the process of creating new series of preferred stock to raise additional funds from sophisticated investors without obtaining additional shareholder approval.

Bridge financing

Interim financing used to meet a short-term, cash-flow need until more permanent financing (typically larger amounts) is secured. For example, bridge financing can be used to carry a firm to an initial public offering, a venture round of financing, or long-term debt.

Burn rate

The rate at which a company that is not profitable uses available cash to cover expenses that exceed revenues; the figure is usually expressed in monthly terms, as in a $100,000/month burn rate.

Business issue

An area that is traditionally negotiated between the clients, rather than attorneys (or in some cases, an area that one or both lawyers don’t want to negotiate for whatever reason).

Call right

A right that enables one person (or the issuer) to purchase securities held by another, usually at a fixed price and after a specified date or the occurrence of a certain event.

Capitalization

The combined sources of equity capital, consisting of convertible debt, common stock, and preferred stock.

Cap table

Short for capitalization table, it is a summary of a company’s issued and outstanding securities.

Common stock

A type of security representing the residual ownership rights of a corporation. Usually, company founders, management, employees, and some angel investors own common stock, while other investors own preferred stock. In the event of a liquidation of a corporation, the claims of secured and unsecured creditors, debt holders and holders of preferred stock take precedence over holders of common stock.

Convertible debt

A debt instrument (such as a promissory note) that can be converted to equity of the issuer (either as common stock or preferred stock).

Co-sale or tag-along rights

These rights enable the holder to participate in a sale of stock from another shareholder to a third party, typically in proportion to the number of shares the holder holds in the company. Co-sale rights are usually designed and intended to protect the holder if a founder or a majority shareholder decides to sell his, her, or its interest in the company. The co-sale rights holder can participate in the sale, usually on the same terms and conditions as the founder or majority shareholder.

Covenant

A contractual obligation to do or not do something in the future. For example, an affirmative covenant could be to provide quarterly reports to investors and a negative covenant could be to not enter into another financing without enabling existing investors to participate.

Cram-down financing

A financing that results in significant dilution of non-participating existing shareholders, usually reducing the value of the inon-participating existing shareholders’ original investments or the rights held by such non-participating existing shareholders.

Cumulative dividends

Dividends that accrue when unpaid and must be paid out before dividends are paid to subordinate classes of stock.

Deal flow

The amount of potential investments that an investor reviews in a given period of time.

Demand registration rights

Rights that enable a holder to demand that the company register the stock held by such holder under the Securities Act of 1933 in order to enable the holder to sell the stock in the public market without restriction.

Dilution

The reduction in the ownership percentage of shareholders caused by the issuance of new securities or the conversion of convertible securities of the issuer, typically with the connotation that the new securities are issued at a lower price than that paid in the previous round of financing.

Discounted cash flow

A valuation method in which the present value is calculated of anticipated future company cash flows.

Dividend

Payment made by a company to the owners of one or more of its types of securities.

Down round

A financing in which the new securities are issued at a lower price than the previous round of financing.

Drag-along rights

Rights that enable a shareholder or group of shareholders (usually those who own a controlling interest in the company) to compel other shareholders to sell their stock in the event a purchaser desires to purchase more than what the controlling shareholder(s) own(s).

Due diligence

A prudent and proper investigatory process to assess a company and the viability of a potential transaction.

Earn out

An arrangement in which sellers of a business may receive additional future payments if certain financial performance metrics are met.

Exit strategy

The method or plan for enabling shareholders to sell their shares and earn a return on investment. Typically, it refers to either the sale of the company or a public offering.

Founder

A person who participates in the creation of a company.

Founders’ stock

Nominally priced common stock issued to founders, officers, employees, directors, and consultants at or around the time a company is formed.

Full-ratchet, anti-dilution protection

Rights that enable investors to reduce the share price at which they can convert their earlier investment or debt to the lower price per share that the company subsequently sells or issues its securities.

Fully diluted basis

The total number of shares of common stock issued by a company, assuming all warrants, options and other rights are exercised and all preferred stock and other convertible securities are converted to common stock.

Initial Public Offering (or IPO)

The first registered offering of securities to the public that is in compliance with the Securities and Exchange Commission requirements.

Inside round

A round of financing in which the investors are the same or a subset of investors that invested in a previous round.

Institutional investor

Large, licensed entities that invest capital on behalf of companies or individuals.

Investment banker

A firm that raises capital, trades in securities, or facilities or brokers mergers and acquisitions (or a combination of some or all of the above).

Issuer

Refers to the company that issued or sold its securities.

Joint venture

An agreement or understanding between two or more companies in which the companies work together for a particular business undertaking.

Lead investor

The investor who manages the negotiation, documentation, and closing of a round of financing, and typically makes the largest investment in such round.

Liquidation preference

The amount of assets holders of preferred stock are entitled to prior to any distribution of assets to holders of common stock upon a liquidation event, such as the dissolution or sale of the company. The preference amount is often based on the original purchase price paid by the holders of preferred stock, or a multiple thereof (e.g., a 2x liquidation preference).

Living dead

Refers to investors who go through a few down rounds of financing, are unwilling or unable to invest any more, and for whose interests in the company there is no liquidation event on the horizon. When the term is applied to a company, it means that the company continues to operate, even though the company is insolvent or has little chance of thriving.

Lock-up provision

A contractual requirement that for a period of time (such as 180 days) a shareholder is restricted from selling such shareholder’s securities following a public offering.

Mezzanine financing

Typically a hybrid of debt and equity financing that is used to finance the expansion of an existing company. It is generally subordinated to debt provided by senior lenders, such as banks

No-shop requirement

A contractual requirement that prevents a company from soliciting or negotiating other deals for a specified period of time, while it is exclusively negotiating with a potential investor, group of investors, or acquiror.

Outstanding stock

Shares of stock that have been issued and are not held by the issuer

Participation right

A right that enables the holder to purchase the holder’s pro-rata percentage of the company’s equity securities in future rounds, enabling the holder to maintain his, her or its percentage ownership in the company.

Participating preferred stock

Preferred stock that entitles the holder not only to holder’s stated liquidation preference, but also allows the holder to participate in liquidating distributions to holders of common stock after the initial liquidation preference is distributed to the holders of preferred stock.

Payment in-kind dividends

A dividend paid in equity rather than cash.

Pari passu

A Latin term referring to the equal treatment of two or more parties in an agreement. For example, an investor may want to have a certain right that is pari passu with investors in a previous financing round.

Pay-to-play

A requirement that in order retain a right, the holder must do or pay something in the future. In the venture capital context, if a holder of preferred stock desires to maintain certain rights as a preferred stockholder, he, she, or it must participate and invest pro rata in future financings or lose those rights.

Piggyback registration right

A right that enables an investor to force an issuer to register the investor’s previously issued, but unregistered shares of the issuer in the event the issuer decides to register some of its other securities.

Placement agent

An individual or firm that assists with identifying investors to purchase securities.

Portfolio company

A company that has received an investment from a venture capital fund is said to be a portfolio company of that venture capital fund.

Post-money valuation

The value of a company after investors invest in a given round of financing.

Pre-emptive right

The right of an existing shareholder to purchase such shareholder’s pro rata share of any new stock that is being issued by the company prior to that stock being offered to new investors. Pre-emptive rights are similar to participation rights.

Pre-money valuation

The value of a company before investors invest in a given round of financing.

Preferred stock

Stock that gives its holders certain rights, preferences, and privileges over holders of common stock and other securities.

Private placement memorandum (PPM) or offering memorandum

A document explaining the details of an investment opportunity related to the sale of unregistered securities to potential investors.

Put right

A right that enables the holder to force the company or another investor to purchase the holder’s securities, usually for a prior agreed upon price, after a specified date or the occurrence of a specified event.

Qualified public offering (QPO)

A public offering that meets certain requirements, as agreed between investors and an issuer, such as a minimum amount or a specified return for holders of preferred stock.

Reg D or Regulation D

Refers to certain alternative rules promulgated by the Securities and Exchange Commission that enable an issuer to sell its securities with certain restrictions, without registering them, to a limited number of people, most or all of whom must meet certain standards of sophistication or wealth (see “accredited investor”). Each rule under Reg D has different requirements, such as those relating to the size of the offering, the number of investors, and the types of required disclosures.

Redeemable preferred

Preferred stock that can be redeemed by its holder in exchange for a prior agreed upon price.

Rights offering

An offering of securities only to current shareholders of an issuer.

Road Show

A series of presentations made in several cities to potential investors.

Securities and Exchange Commission (or SEC)

The federal agency that is in charge of enforcing the federal securities laws and regulating the securities industry (including the stock exchanges).

Stripped down preferred

A type of preferred stock that carries only the very basic rights of preferred stock (e.g., a liquidation preference), but does not carry the variety of other rights (contractual or otherwise) frequently associated with the issuance of preferred stock.

Syndicate

A group of investors that participate in a round of financing or a group of investment banks that participate in a public offering.

Term sheet

A document that outlines the key terms of a proposed transaction. The term sheet is typically non-binding, except for certain provisions.

Underwater option

An option is underwater when the current fair market value of the underlying shares is less than the option exercise price to purchase those shares.

Veto rights

Negotiated rights that enable the holder to prevent a company from taking certain actions or cause it to take certain actions.

Warrants

A derivative security that gives the holder the right to purchase securities (usually common stock) from the issuer at a specific price within a certain time frame.

Weighted average anti-dilution protection

Adjusts the investor’s conversion price downward based on a weighted average formula reflecting the number of new shares sold and the new price per share at which the additional shares were issued. It can be a narrow-based, weighted average or a broad-based, weighted average. Compare to full-ratchet anti-dilution protection.

by Matt Storms |

 
 

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