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That Every Entrepreneur Must Know

  • Angel Investor

Angel investors invest small amounts of money in startups.  The term's origin is from the 1920's, to describe a new investor in a new Broadway play.

  • Hedge Fund

Hedge funds pool investors’ money and invest the money in an effort to make a positive return. Hedge funds typically have more flexible investment strategies than, for example, mutual funds. Many hedge funds seek to profit in all kinds of markets by using leverage (in other words, borrowing to increase investment exposure as well as risk), short-selling and other speculative investment practices that are not often used by mutual funds. 

  • ‚ÄčSeed Round

The first money a startup receives, typically from many angel investors, or on GeeFunding.  While there are exceptions, most seed rounds raise between $250,000 and $2 million.  

  • Issuer

This is what lawyers call a company when it is issuing securities.

  • Series A

The "A" is the first significant investment by a venture capitalist or very large investor. 

In the past, startups raised between $2 and $5 million for their Series A. In recent years, some of the best startups have been receiving well over $10 million from their first venture capital investment. It's been getting cheaper for startups to make more progress with their seed funding, increasing their price when venture capitalists finally invest.

  • Burn Rate

This is how much cash the startup is "burning" each month.

If a startup has $10,000 in revenue in April, but $100,000 in expenses, their burn rate is $90,000. 

  • Runway

The amount of time (usually expressed in months) before the startup goes bankrupt without additional funding. 

For example, if a startup has no revenues, has expenses of $20,000 per month, and has $100,000 in the bank, it has a "runway" of five months.

It's common for most startups to have between 6 to 18 months of runway.  

  • Securities

A security is a fancy way of saying investment contract.  It can be debt or equity.

In 1946, the Supreme Court defined a security as anything that meets these four criteria. 

  1. It is an investment of money
  2. There is an expectation of profits from the investment
  3. The investment of money is in a common enterprise
  4. Any profit comes from the efforts of a promoter or third party
  • Carried Interest

Carried Interest is a share of the profits from an investment.  It's how venture capitalists make money from their own investors (called limited partners), typically when a startup is acquired or after an IPO. 

Example: A venture capitalist invests $1M at a $10M valuation. In five years, the initial $1M of equity is sold for $300M. If carried interest is 20%, the venture capitalist would earn $59.8M [($300M - $1M) * 20%]. 

  • IRR

IRR stands for "internal rate of return".   Unlike a simple exit multiple, IRR takes into account how long it took to earn a return.  

It's a harsher way of judging the success of your investments. For instance, let's assume you invest $100, that six years later, is worth $200.  Instead of saying, "Wow, that's a 200% return!", you'd say, "That's an IRR of 12.2%".

IRR for angel investors is very long-term. It can take up to 10 years to be able to sell your investments.  So we often talk about realized and unrealized IRR.  An realized return is when you sold the stock and have the cash.  An unrealized return is the estimated amount the stock is worth, usually based on the last price other venture capitalists have recently paid for it.  

Here's how to calculate it:  The IRR on an investment is the annualized effective compounded return rate that would be required to make the net present value of the investment’s cash flows (whether they be cash in or cash out) equal to zero. NPV = NET*1/(1+IRR)^year).  Or just use XIRR in Excel.

  • Fundraise Exemption

Startups must qualify under one of several federal exemptions from securities registration. Otherwise, they are violating securities law.  Exemptions supported on GeeFunding include Regulation D, Regulation A+, and Regulation Crowdfunding.

  • Regulation 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 occurred this way until late 2013.

There's one catch. Companies using Rule 506(b) cannot advertise their fundraising

  • Regulation 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 can raise an unlimited amount of capital from Accredited Investors . But unlike 506(b) these startups canadvertise their fundraising to the public.

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.

  • Regulation A+

Also known as Title IV of the JOBS Act, Regulation A+ allows startups to raise up to $50 million per year from an unlimited number of investors, no matter how wealthy they are. Companies can think of Regulation A+ as a mini-IPO, allowing them to gauge public interest without the strenuous fees and reporting requirements of actually going public before they're ready.

Investors are also limited in the amount of capital they may invest in Regulation A+ startups per year. Non-accredited investors may legally invest no more than 10% of their income or net worth—whichever is greater. Accredited investors (those who have an income of $200K+ or have a net worth of over $1 million) have no investing limit.

To find out your investment limits, open an investor account.

  • Common Stock

Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure; in the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debtholders are paid in full.

  • Discount Rate

The discount rate is a term in a Convertible Note or SAFE that gives investors a reduced price to that paid by the Series A investors.  Typical discounts range from 0% to 20%.

Let's say you hold a convertible note with a 20% discount rate. If a venture capitalist invests in that company at $20 million valuation paying $3 per share, your note converts to equity at $2.40 ($3.00 * .8) per share. Note that discount rates usually are only applied when the valuation is below the Valuation Cap.

  • Interest Rate

The interest rate is the amount charged by a lender, usually expressed as a percentage of principal annually.

Convertible notes also carry an interest rate. Unlike traditional loans, however, this interest is paid in additional shares upon conversion of the note instead of cash. Let’s say you invest $1,000 in a startup through a convertible note with a 5% interest rate. If they receive a series A investment one year later, you would have accrued $50 worth of interest and would be entitled to $1,050 worth of shares at the appropriate conversion rate.

While Convertible Notes have an interest rate, the interest and principal are rarely repaid in cash; rather, the accumulated interest entitles the investor to receive more stock if and when the note converts to equity.

  • Preferred Stock

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

  • Pre-Money Valuation

The pre-money valuation is the valuation of the company before an investment has been made. It does not include the value of the cash a venture capital firm is about to invest. Pre-money valuations for early-stage startups are most often determined by supply and demand. 'Hot' startups often have multiple venture capitalists chasing after them, and therefore command a higher valuation.

  • Post-Money Valuation

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

For instance, a venture capitalist might determine a company has a pre-money valuation of $15 million. The VC then invests $5 million in exchange for a fourth of the company. The post-money valuation is $20 million.

  • Valuation Cap

The Valuation Cap is the most important term of a convertible note or a SAFE. It entitles investors to equity priced at the lower of the valuation cap or the pre-money valuation in the subsequent financing. Typical Valuation Caps for early stage startups currently range from $2 million to $20 million.

The valuation cap is a way to reward seed stage investors for taking on additional risk. The valuation cap sets the maximum price that your convertible security will convert into equity. To translate that into a share price, you divide the valuation cap by the series A valuation. 

Let's say you invest in a startup using a note with a $3 million cap. If the series A investors decide that the company is worth $6 million dollars and pay $1/share, your note will convert into equity AS IF the price had actually been $3 million. By dividing $6 million by $3 million we get an effective price $.50/share. That means that you will get twice as many shares as the series A investors for the same price.

  • Tax ID or EIN

Employer Identification Number (EIN), also known as the Federal Employer Identification Number (FEIN) or the Federal Tax Identification Number, is a unique nine-digit number assigned by the Internal Revenue Service (IRS).

  • Fiscal Year End

The business’ fiscal year is any twelve-month period that the company uses for accounting purposes. It can be the end of any quarter, but it's most often December 31st.

  • Warrants

Like an option, warrants grant the right to buy stock at a certain price in the future. Unlike options, warrants (and the shares they convert into) are always issued by the company itself.

  • Board of Directors

The Board of Directors have a fiduciary responsibility to guard the interests of the shareholders of a company.

The board makes decisions on major strategic issues and can often (but not always) fire the CEO.  

In an early stage startup that has just raised a Series A, it's most common to have the board members:  two appointed by the founders, and one by the venture capitalist.  Usually at each major subsequent round of funding, another board seat is created.  

The SEC requires that the majority of the Board of Directors sign the Form C to fundraise on Gee Funding. 

  • Principal Security Holder

Someone who controls 20 percent or more of a company’s voting power. 

  • GAAP Financials

The law requires that financials used in a Form C follow the Generally Accepted Accounting Principles (GAAP) format. This includes an income statement, balance sheet, cash flow statement, and notes to the financial statements. 

  • Liquid Market

The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.

Securities sold in Regulation Crowdfunding offers are not liquid. 

  • CIK & CCC Codes

A Central Index Key (CIK) and the CIK Confirmation Code (CCC) are used by the Securities and Exchange Commission to identify companies.  We use it to file Form C's in the SEC's EDGAR system.

  • Articles of Incorporation

Also referred to as a certificate of incorporation, this is the legal document establishing the existence of a corporation.  It's typically filed with the Secretary of State.

  • Account Receivables

The money that a company has a right to receive because it had provided customers with goods and/or services. For example, a manufacturer will have an account receivable when it delivers a truckload of goods to a customer on June 1 and the customer is allowed to pay in 30 days. 

  • Cash or Cash Equivalents

A current asset account which includes currency, coins, checking accounts, and undeposited checks received from customers. The amounts must be unrestricted.

  • Long Term Debt

The amount owed for a period exceeding 12 months from the date of the balance sheet. It could be in the form of a bank loan, mortgage bonds, debenture, or other obligations not due for one year. A firm must disclose its long-term debt on its balance sheet with its interest rate and date of maturity.

  • Net income

An entity's income minus cost of goods sold, expenses and taxes for an accounting period.

  • Total Assets

The basic accounting equation states that assets = liabilities + stockholders' equity. In the accounting industry, assets are defined as anything that a business owns, has value, and can be converted to cash. Assets are broken down into two main categories. These two categories are current assets and noncurrent assets.

  • Revenue

Usually shown as the top item in an income (profit and loss) statement from which all charges, costs, and expenses are subtracted to arrive at net income. Also called sales, or (in the UK) turnover.

  • Cost of Goods Sold

The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. Also referred to as "cost of sales."

Qualifying Transaction

Both instruments call for a conversion to equity when a future Preferred equity round of financing is closed.  However, convertible notes stipulate a minimum amount of money to be raised in the future equity round before being considered a “qualifying transaction” that triggers conversion.  SAFE investments, on the other hand, convert with any amount raised in a Preferred equity round.

Investors will enjoy the SAFE’s removal of the qualifying transaction term because it is something that otherwise could possibly get in the way of converting their investment to equity.  

Term (Maturity Date)

Convertible notes have them but SAFEs don’t and that’s because a SAFE is not considered a debt instrument.

Investors will not enjoy this aspect of the SAFE because it’s the term (maturity date) feature in convertible notes that forces at least some conversation if there’s no natural conversion to equity over time.  Reaching the maturity date on a convertible note also often triggers rights to equity conversion (using a formula that involves the valuation cap).  A startup that uses a SAFE and then evolves into a profitable lifestyle business without ever having to sell Preferred equity could leave their investors in limbo forever.

Peer-to-Peer Lending

This type of lending may be an appealing option to non-accredited investors who would rather invest in individuals than in companies or real estate. Peer-to-peer lending platforms allow consumers to create fundraising campaigns for personal loans. ‚ÄčEach borrower is assigned a risk rating based on his or her credit history. Investors can then choose which loans they want to invest in based on how much risk is involved.

That’s a good thing if you want some control over how much risk you’re taking on. At the same time, it also allows you to gauge what kind of earnings you stand to see on the investment. Generally, the higher the borrower's risk level, the higher the interest rate on the loan, which means more money in your pocket. 

Again, it doesn’t take a huge bankroll to get started with this type of crowdfunded investment. If you’ve got an extra $25.00, you can start funding loans through Peer-to-Peer funding concept when available here at GeeFunding.