Robert Maynard’s Essential Venture Capital Terms

Preferred stock - a class of ownership that has rights not ascribed to common shares. Usually a liquidation preference or a participating preference, voting preference or dilution preference.

(terms defined below) Do not, under any circumstances, give a dilution preference.

parre passu - latin for “we all get what the other gets.” ( I take some literary license here). IOW, if one class of stock is going to get diluted, everyone is getting diluted at the same rate.

Insist on this in any deal you make.

Liquidation preference - if the company sells, the stock with a liquidation

preference gets all their money back before the remaining proceeds are split.

Sometimes they get more than their money back. For instance, a 1X

liquidation preference gets the amount they put in back first. A 2X gets twice

the amount and so on. This is usually a big deal only if the company does not

perform well.

Participating Preferred - a clause on Preferred Stock that allows the holder to

be paid back his money, or some multiple thereof, when the company is sold. For instance, a 3X participating

preferred share would get three times what he put in before common

shareholders get paid. Participation usually falls off in the event of an IPO. I

would never give more than 1X Participation.

Observation rights - The right for an investor to sit in on all board meetings and exec committee meetings without

actually being on the board. Many VC’s are taking positions like this instead of

board seats in order to mitigate liability. You can often counter a request for a

board seat with observation rights. Say he wants two board seats out of five.

Counter one with one observer. They’ll usually take that.

Vesting - award of ownership or options over a period of time. Set it in months rather than years. Thus, a three

year option would vest 1/36th per month.

Reverse vesting - When the founders are stripped of their ownership rights of some

amount of their founding stock (usually half) at the inception of the A round and they have to re-earn it over the vesting period. Do not make these options, make sure they remain

as stock and that you control the voting rights even though they’re not vested. Don’t be offended or frightened off by this. It is a

standard golden handcuff to ensure that the main guys they are investing in stay the

course.

pre-money valuation - the enterprise value of the company without the investment. Let’s say

$8mm.

post-money valuation - the enterprise value plus the amount of the investment. If you get $2mm in investment and your

pre-money valuation is $8mm, then your post-money is $10mm.

tranches (pronounced “traunches”) a staging of the investment dollars subject to hitting specific performance goals. Do not, for any reason, do this. If it’s a deal point, walk away. This is a great way to get screwed. They’ll make it sound so

reasonable, but it’s just a recipe for disaster because nothing goes according to plan, so they can always renegotiate the terms of the deal when you run out

of cash. (Many do).

Option Pool - usually the investor will want to set aside 25% of the equity of the company in an option pool to be split by

employees. I use a different bonus structure for my guys that is very well received and much less expensive for the owners.

Basically, they get a dollar-for-dollar bonus on every dollar they were ever paid during their tenure six months after a

change in control. They must be continuously employed and be employed on the payment date. I find that rank and file love this because it gives them a hard number to look to. If you pay them market rates (I always do) then this is a fair

distribution in return for the work they had to do as a startup. It is MUCH cheaper for the owners/founders, is

much less distracting from a management perspective and serves as a poison pill for someone who wants to buy you

cheap. I save equity awards for C-Suite execs and Directors.

Strike Price - the amount paid for a share of stock when an option is exercised. The value

of the compensation is the market value - strike price. Always make the strike price the same as the last round of financing or more.

There is no need to provide cheap options anymore. Indeed, accounting for cheap

options is a nightmare. If you're bringing someone on after the first investment is made, price the option at whatever the

investor paid for his shares.

Rule 144 shares - You have to hold this stock for a year (if the company is public) before you can trade it. This is especially important in the case of options

in that you will be taxed for the value of the compensation at the time you exercise the options,

but you will not be able to trade for a year. This means that you come out of pocket to buy the stock and pay the taxes a year before you get the money from the sale of the shares, all the while taking the market risk on the appreciation of the shares. This is a hidden poison pill that makes options almost

impossible for normal people to take advantage of. A good VC would never try this, but an unscrupulous

investor or acquirer might.

Rule 8A - the filing that makes options tradeable immediately so that you can exercise your option and sell it on the same day. Insist

that there is a clause in any vested options you give that force an 8A filing at some trip point, usually six months after an IPO.

Exercise date - the amount of time you have to buy your vested options before they are retrieved by the company should you leave before a liquidity event. Remember that, unless you’re public, these options will be treated as rule 144 stock until the stock is

registered and publicly traded. This is a very important component of comp plans. Even if

you vest, if you can’t afford to exercise and pay taxes, you lose the vested options if you

leave.

Due diligence - They will look up your ass and out your eyes. Don’t get offended when they ask the same question 15 times. They're not stupid (usually), they're just trying to see if you've

thought through all sides.

Cap Table - the list of who owns what in the company, how much they paid,

when they paid, what they paid with (cash or services) their tax id #s, contact

info including phone, email and hard address as well as any vesting schedule. Once this is published after a funding, it is almost impossible to change. Make

sure it's right from day one and that it is kept completely up to date.

Deferred compensation - if you have been taking a smaller than market (or no) salary (this should be true of any of the execs at seed stage) make sure you record the full market salary as an expense and setup a

liability account called deferred comp for that amount that is not paid in cash. This account

would be paid on closing of the round (or some negotiation about it). It’s a good way to get your market rate even though you haven’t

been taking it the whole time.

Board meetings - do not agree to any more than four formal meetings a year. Otherwise, you will be spending your days doing decks for the board rather than running the business. However, communicate with your board at least every month in writing with

financials, waterfall reports, good bad and ugly developments. Remember to always communicate bad news early and loudly. No one expects you to

be perfect and anyone on your board should be experienced enough to understand the rough times.

Indeed, they are there to help you through them, not to whip you when they happen.

Accredited investor: Someone who has earned $200k per year for the past two years if single, $300k per year for two years if married or has $1mm in net investible assets excluding their home. (There are other requirements for things like trusts, corporations, etc. Your lawyer can help you with these) You want to ensure that all of your investors are

accredited for two reasons: first and foremost: you should never take a dollar from someone who can’t afford to lose it. Chances are you’re

going to fail. When people can’t lose the money and don’t understand the risk, they get very upset, file lawsuits, make noise on social media and just generally try to ruin your reputation. Don’t ever take money from people who can’t afford it. Stress in your presentations that the

money is completely at risk. I liken it to putting it all on Red 00 in roulette. You’re either going to win big or lose it all. The second reason

is for regulatory purposes. Different states have different rules for registering if your investor pool is not entirely accredited. The rules are

basically the same as being public. No startup can afford that type of regulatory cost.

Term Sheet: This is the non-binding agreement that the VC will give you if

he's ready to proceed to making a deal. It outlines the basic terms (wow, what a circular definition) of the deal. Get the

term sheet right, but don't over-complicate it. It should be produced on one sheet of paper. Remember that it's

non-binding, so you don't have to get crazy with legal language.

No-look: This is a term of time when you agree not to shop your deal to any other VC's. For the most part, this is a bad idea, especially if you are not cash-flowing. Under no

circumstance give this away without getting something in return (expedited diligence, breakup fee if they don't fund, more elastic terms, higher valuation, something).

Seed Round: This is the tranche of money you raise, usually from yourself or friends and family, that is used to get a working product put together and get a little traction in the

marketplace. You usually have to get to something like $50-100k per month in

revenues on your seed round with a good growth trajectory in order to attract a good

VC. Consider this the proof-of-concept stage. This is by far the hardest money to raise.

Treat every dollar as if it were worth $100.

Series A Round: This is the tranche where you get your first one or two good VC's. It's usually priced at about 20% - 25% of the overall company (meaning, you get $2.5mm and they

get 25% or whatever the ratio ends up being). With this money, you should be able to prove out that there is a viable

market for your product and that you have the ability to penetrate it. I personally believe that you should have a

viable business when you run out of A money. That is, if you had to, you could turn off the growth engine and have a

business that cash flows. It's growth that costs money. If you're not able to raise another round of financing, you'd

better be able to stop growing and live on what you've killed. The big lesson here is treat every dollar as if it's worth ten.

Do NOT get crazy with hiring at this point, especially administrative types.

Series B Round: This is the tranche where you turn on full afterburner. You've proven the market exists and that your product is

accepted. You've proven that you have the team that can exploit the market. Series B is

where you lay on the staff to make it a big business. You should have an operating

business when this money runs out, including financing the growth engine. Typically, VC's will get 15% of the company for a B round

and the amount can be as high as $200mm. Whatever it is, it will be a big number, usually

8-10X of your A round.

Series C and beyond: These rounds are saved so that you have a big business that is ready to go

public or be bought for big dollars. Your executive team is well established. You may want to use some

of this money to go into new products or buy another company. Whatever it is, be careful taking this money. If you're a hot company, everyone will

want to give it to you, but it's easy to get over-diluted. It's also easy to let the success go to your head. Don't be afraid to cash out a bit if you take a

C round. Meaning, sell a bit of your stock to the investor so that you're diversifying and put some cash in your pocket. They might give you a bit of grief for it at first, but it's not an unusual use of

proceeds for a later round.