Have you ever sat through a startup finance workshop or listened to an investor panel and felt like they spoke in complete gibberish? If so, you’ve come to the right place. Many early-stage founders struggle with startup funding vocabulary. There are so many terms thrown around that sometimes they can go over your head. As a founder, it can feel intimidating and embarrassing when you don’t know the meaning of commonly used terminology within the startup community. That’s why we’ve created a glossary of startup funding terms to give you a head start. Review this glossary of words, and you’ll impress seasoned entrepreneurs and investors with your advanced knowledge of startup funding!
Are you wondering how to use this glossary? Don’t worry! To add some method to the madness, we’ve categorized these terms by startup stage. That way, for each step of your startup journey, you will have a deep understanding of the most commonly used words. Don’t feel pressured to memorize all these terms at once. Much of the later-stage vocabulary will be irrelevant to you if you’re at the ideation or pre-seed stage. Instead, feel free to give this guide a quick read and bookmark this page for future reference as your startup makes its way through the various stages.
Ideation: A startup process for generating solutions to consumer pain points. Here is where brainstorming and prototyping come into play to produce a product or service to solve the defined problem.
Target Market: The group of consumers that would be using your product or service. Characteristics such as demographics, geographic location, income, education, and lifestyles help to differentiate consumers in this category.
Startup Capital: This type of capital is the money required to start and operate your business. Sources of this capital can include your personal savings and investments from your inner circle of friends and family.
Minimum Viable Product (MVP): The product or service your company offers in its most basic form, usually for testing. The purpose of using an MVP is to test and iterate quickly by learning from your customers. An MVP discourages spending too much time and money on perfecting the product.
Key Performance Indicator (KPI): Key performance indicators allow businesses to measure progress made towards organizational goals. The process of using KPIs includes setting goals, tracking progress, and making decisions about your company based on the data.
Business Model: A business model defines how the startup intends to make a profit. Startups need to understand how their product or service fits their target market and what key actors and resources are involved in the process of creating their offerings.
Profit Margin: A measure of profitability when taking business expenses into account. To calculate this figure, subtract total expenses from sales and divide by revenue. Then, multiply the resulting number by 100, and you will have your profit margin.
Churn Rate: The rate at which a startup loses customers during the acquisition process. To calculate the churn rate, divide the number of customers you lost last quarter by the number of customers you started with at the beginning of the quarter.
Proof Of Concept: The ability to demonstrate the viability of your startup idea or business through consumer validation and market testing.
Product Market Fit: An equilibrium between product and market. A point where the product or service offered by a business creates enough value to satisfy customers. For an in-depth tutorial on how to achieve product market fit, check out our blog here.
Incubator: An organization that helps entrepreneurs turn business ideas into operational startups. An incubator is usually a space where entrepreneurs can gather, prototype, network, and receive mentoring.
Pivot: A point in which a business decides to move in a different direction based on feedback from the market.
Equity: The division of ownership within a company. For example, investors may trade capital in exchange for equity or shares.
Bootstrapping: Founders who invest their own money and raise funds from personal contacts like friends and family instead of traditional loans and investors. An attractive benefit of bootstrapping is no loss of equity.
Accelerator: Startup accelerators are programs that provide early-stage startups with resources to help them become successful. Many programs include workshops, mentorship, competitions, and networking.
Scalability: A business is scalable if it meets specific criteria that indicate the capacity to grow. A company has scalability when it can demonstrate its readiness to meet an increase in market demand.
Cash Flow: The money that flows into and out of your startup. A positive cash flow means there is more money coming in than leaving. A negative cash flow means more money is going out than coming in.
Burn Rate: The rate that your company spends money. Two common KPIs include gross burn rate, which refers to the amount of money spent each month, and net burn rate, which refers to the difference between cash in and cash out.
Runway: The amount of time your startup has before running out of cash to pay for its expenses. Calculating your runway is as easy as dividing your cash balance by net burn rate.
Alpha Test: Startups often use this internal test of a new product or service to determine whether it meets expectations and functions correctly.
Beta Test: A user-based test that directly follows successful alpha testing. Beta tests are where businesses learn from consumers in the real world and help validate an offering’s functions, ease of use, and compatibility with the target market.
Sales Funnel: A funnel-shaped depiction of total potential customers that filter to only a few “perfect customers” who end up making a purchase. Stages of the sales funnel include awareness, interest, consideration, and purchase. (Picture)
Cash Position: The amount of cash your business has in its reserve at a single point in time. Your cash position is directly tied to your cash flow and indicates your startup’s ability to take on risks.
Venture Capitalist: A seasoned investor who recognizes growth potential in your startup and provides funding in exchange for equity in your company. A venture capitalist usually plays a more active role in the decision-making process of your venture.
Angel Investor: An investor focused on helping you grow your early-stage startup. Angel investors are usually retired entrepreneurs or executives with considerable experience.
Valuation: The current or projected value of your company. Many factors determine your company’s worth, including demand, market size, and projected revenue. Pre-money valuation is estimated before receiving any funding, and post-money valuation is estimated after receiving funding.
Convertible Note: Startups can issue a short-term debt instrument called a convertible note to investors and use it as a bridge investment before or in-between funding rounds. Convertible notes are agreements between startups and investors who loan money to the startup. Instead of receiving repayment in the form of principal and interest, they will eventually convert the note into equity in the business for the investor.
Using convertible notes has several advantages. Convertible notes are not regular loans, so there are no monthly payments to consider. They can be directly injected into the business without incurring additional operating expenses. They can also be very flexible as far as the terms for repayment. A convertible note is an agreement between your startup and an investor, so there is room for negotiation to better suit your needs. Convertible notes are also a great incentive for both parties to succeed. Investors are motivated to receive their payment in equity at the subsequent financing round, so they are more likely to take on an advisor role.
Discount Rate: When early investors take on additional risk before a startup’s financing round, they can purchase equity in that company at a reduced price.
Here is a basic example of calculating a convertible note with a discount. From the graphic, we can see that Company X is raising Series A funding. This event can trigger a maturity event where an investor receives equity in exchange for the convertible note. Investors valued the company at $10,000,000 during Series A, and the Discount is 20% in the terms of the note. In this case, to figure out the discount share price, we subtract the Series A share price by the discount. Then we take the investment amount and divide it by the discounted share price to figure out the equity at conversion. This investor will receive $625,000 or 625,000 shares at the series A share price of $1.00. Not bad!
Cap: The maximum valuation of equity for a convertible note. Convertible notes typically allow investors to pay less per share than those entering at a later equity investment round.
Here is a basic example of calculating a convertible note with a cap. From the graphic, we can see that Company X is raising Series A funding. This event often triggers a maturity event where an investor receives equity in exchange for the convertible note. Investors valued the company at $10,000,000 during Series A, and the Cap is $5,000,000 in the terms of the note. In this case, to figure out the cap share price, we divide the cap by the valuation. Then we take the investment amount and divide it by the cap share price to figure out the equity at conversion. This investor will receive $1,000,000 or 1,000,000 shares at the series A share price of $1.00. That’s a great return on investment!
Interest Rate: The interest rate on a convertible note does not work the way you would traditionally think. Interest is not paid in cash but rather to the original principal, which later converts to equity in the company or increases the number of shares they will receive.
Maturity Date: The date the convertible is due is usually triggered by an event like a funding round, acquisition, or liquidation. The company also needs to pay any interest if applicable.
Equity Financing: The practice of selling shares to venture capitalists and angel investors.
Debt Financing: Securing capital from a traditional loan or a financial institution. Startups can use Short-term financing for cash flow issues, whereas long-term financing is reserved for purchasing more considerable assets such as inventory, machinery, or real estate.
Customer Acquisition Cost (CAC): The CAC is the total cost of acquiring a new customer. To calculate the CAC, one must consider advertising cost, marketing spend, and customer service expenses.
Series A: Once you’ve reached series A funding, your startup should have demonstrated enough traction with your product that venture capital is now interested in exchanging money for equity. Investors at this stage want to see your startup’s long-term plan for survival and a clear path towards expanding your market reach.
Preferred stock: Shareholders with this stock lack voting rights and suffer minimal risk should their investment decrease in value. In addition, these investors may have liquidation preference or other mitigating factors to recuperate their investment.
Common stock: Typically held by founders and employees of the company, this stock option gives shareholders voting rights in proportion to the number of shares they own.
Market Penetration Rate: The Market penetration rate is the volume of products sold divided by the estimated target market. The rate is always expressed as a percentage.
Competitive Advantage: A key differentiator that allows your startup to outperform other companies in the market. Companies can compete on price, innovation, brand recognition, quality, distribution strategy, and customer service.
Run Rate: The estimated future financial performance of a company based on the startup’s current financial conditions and assumptions.
Due Diligence: A review of a business’s financial performance, intellectual property, and team before investing.
Series B: Typically a funding round for startups looking to scale, depending on a startup’s rate of growth and performance. Companies looking to raise series B capital will have solid product market fit, increasing demand, and a plan in place for scaling operations.
Series C: This late-stage investment round brings new capital to the table, including private equity, hedge funds, and late-stage venture capital firms. Companies raising a series C round have been very successful and are looking to expand their operations. Funding from this round is usually in the tens of millions.
Drag-along Rights: A provision in an agreement allowing a majority shareholder to force a minority shareholder to agree to the sale or merger of a company.
Term Sheet: A formally written but non-binding contract that specifies the terms and conditions for investing. Think of this as the draft before the actual legally binding documents are drawn up.
Dividends: Payments made on a regular schedule by a company to its shareholders from profit or reserves.
Securities: A company can trade these financial instruments that hold a monetary value. Securities include equity, debt, or a combination of both.
Cap Table: A spreadsheet containing a complete list of a company’s stocks, convertible notes, securities, and their respective owners.
Dilution: A dilution of equity occurs when existing shareholders lose a percentage of their ownership in the business as the company issues new shares.
Stock Options: Contracts allowing a buyer the right to buy or sell a stock at a set price for a specified period. A call option allows a buyer to purchase stock at a fixed price even if the stock price exceeds that amount. A put option allows the buyer to sell the stock at a set price even if the stock price decreases below that amount.
Bridge Financing: A short round of funding that can keep a company afloat in between larger rounds. Funds can be raised as either debt or equity funding and usually consist of repayment.
Mezzanine Financing: A financing option that includes a hybrid of debt and equity financing. These loans can carry higher interest rates.
Pro-rata Rights: An investor’s right to maintain the same level of ownership in a company even if followed by more rounds of funding.
Initial Public Offering (IPO): The IPO is when a privately held company decides to go public by offering shares in exchange for capital.
Exit Strategy: A plan for founders and venture capitalists to exit a business venture. An exit strategy is executed when someone cashes out or sells their interest in a business. This plan can commence when a company is profitable or to minimize losses.
Liquidation: Selling a company’s assets and inventory to cease operations.
Liquidation preference: The order in which stakeholders get paid as a company begins to liquidate. For example, a contract may state that investor A will receive payment from liquidated assets before investor B.
Mergers and Acquisitions: Mergers and acquisitions occur when one company purchases another. Mergers and acquisitions can be an exit strategy for a company or a competitive approach to reduce competition or buy another company’s intellectual property.
Vesting: Vesting is the practice of giving present or future payments, assets, or benefits such as stocks to founding members or employees. Vesting typically accompanies a vesting schedule that determines the time and period the benefits are “paid out.”
Buyout: A transaction where one company buys a controlling share of another company.
If you’ve read through the entire list of startup funding terms, you’re already a step ahead of the game! The point of this list isn’t for founders to memorize all these funding terms at once, so don’t worry if you can’t remember everything you’ve just read. At Future Founders, we recognize funding is complex, and it can be incredibly intimidating for new founders to ask questions. Our mission is to empower young entrepreneurs to follow their passions and break down barriers that prevent them from achieving their dreams. Check out our programs, including our Startup Bootcamp, designed to help entrepreneurs turn their idea or side hustle into a functioning business!
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