Legal Information for Entrepreneurs
Common Venture Capital Legal Terms and Conditions
Raising money from venture capitalists requires that you be fluent in venture capital terms. If you are raising investment money and don't know what a liquidation preference is or what ratchet antidilution means, you are going to lose in the VC negotiations. Educate yourself on VC term sheet terms before you start knocking on VC doors.
The world of venture capital is an enticing prospect for small business owners.
The right relationship with the right venture capitalist can catapult a business to the next level of success. But developing the right relationship can be tough, especially if you don't speak the language. To help you get started, here are some terms commonly spoken in venture capitalism circles.
Initial (or Seed) Round
Venture capitalists provide funding in rounds. Each round represents a different phase of the business or a specific set of goals. The initial round of funding is usually a developmental phase in which the company is challenged to prove a concept or adapt a product to be marketed in a later round of funding.
The pre-money value is the value of a business prior to the introduction of capital from a venture capitalist. This figure is used to determine the percentage of ownership the venture capitalist(s) will retain in the business after their investment. Businesses want this figure to be as high as possible while venture capitalists prefer a lower number.
The post-money value is the value of the business after the venture capitalist's investment has been taken into account. The venture capitalist's ownership percentage is calculated by dividing the post-money valuation by the venture capitalist's investment.
Dilution refers to the reduction in the percentage of ownership as the number of investors increases. Although a business owner's percentage of ownership may decrease, the actual value of his ownership may increase due to the steadily increasing value of the company.
Each round of investment is lead by a lead investor, a venture capitalist or venture capitalism firm who spearheads the round, negotiates the terms, and provides 50% of the required investment. From a business owner's perspective, the lead investor can make or break an investment round since a strong lead investor can easily entice additional investors to participate in the project.
Due diligence refers to the process by which venture capitalists conduct research on a company that is candidate for investment. It's not unusual for due diligence to be broken down into two sub-categories: Business due diligence and legal due diligence.
A liquidity event is any event that triggers the ability for venture capitalists or other investors to terminate their relationship with the business and cash out. The most common liquidity events are IPOs (Initial Public Offerings) or company acquisitions.
The exit strategy is the business owner's plan to convert the venture capitalist's investment to cash. Although this can happen through an IPO, it most frequently occurs when the business is acquired by another company.
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