Are you planning to give investment pitches to raise funds for your startup? You need to know the basic terminology associated with fundraising to prepare for your next fundraising conversation and present yourself confidently.
In this post, we’ll discuss the basic terms which founders must know before preparing their pitch decks or going into fundraising meetings.
1. Burn Rate:
Burn rate is the speed at which a company spends money before generating a positive cash flow. Burn rate is a key factor in a company's sustainability and is measured on a monthly basis.
Burn rate is of two types: gross burn rate and net burn rate. The gross burn rate is a measure of a company’s operating expenses. It is calculated by totaling all its operating expenses. It also provides insight into a company’s cost drivers and efficiency.
Net burn rate is the rate at which a company is losing money. It is calculated by subtracting the operating expenses from its revenue. It is usually measured in cash spent per month and is 0 at break even.
Runway is how long a company can run operations with its current bank balance. As a founder, you can either reach a positive cash flow or raise enough money.
If your net burn rate is Rs 20,00,000 per month and you have Rs 200,00,000 in the bank, your runway is 10 months, that is, you'll run out of cash in 10 months.
3. Term sheet:
A term sheet is a non-binding agreement that lays out the basic terms and conditions to be agreed on by both founders and investors during fundraising. These terms are negotiable and serve as a basis for more detailed, legally binding documents.
The term sheet will include details, such as the investor commitment, valuations, type of security, the percentage of stakes, anti-dilutive provisions, pro-rata rights, right-to-first-offer, right-to-first-refusal, etc.
3 Key things to watch out for in your term sheet
A capitalisation table, or cap table, is a record of a company’s ownership of securities (e.g. common or preference shares, convertible instruments, warrants etc.). Simply put, a cap table shows “who owns what” and “what proportion of the company a shareholder owns”.
A cap table helps founders manage ownership of their stakeholders and also help derive the price of the equity instruments they own in the company. Mistakes in the cap table can lead to problems later, such as unexpected dilution of equity and disputes with other stakeholders, which can manifest into legal issues.
Traditionally, cap tables were maintained in spreadsheets which consumed a lot of time and effort to manage, and they were prone to errors too. Qapita, a cap table management tool, digitises cap tables and makes companies investment-ready.
5. Due Diligence:
Due diligence means examining the details to confirm all facts on things of significance, such as making an investment, merger or acquisitions decision, etc. The reviewed facts could include financial records, legal records, and anything else deemed material.
Due diligence enhances the amount and quality of information available to decision-makers. It ensures that this information is systematically used to make well-informed decisions balancing the costs, benefits, and risks.
Exit means how a founder or investor will cash out a part of or his total equity from his startup. A complete exit is the point where a founder or investor leaves the company. This occurs when he sells his shares in the startup to another investor or a company.
The common ways of exiting from a startup are selling, merger, acquisition or going public (IPO). Determining which strategy is best for one relies mainly on the current state of the startup and their future goals.
Using Qapita, you can model scenarios to know your payouts in different exit conditions.
7. Churn Rate:
It is a business metric to measure how many users or customers you’re losing in a specific period. High churn rates create a negative perception about the product or service which you offer and can be a hurdle in raising funds.
Churn rate is an important metric for recurring business models—like SaaS and other subscription-based companies. A VC backed startup should maintain their churn to have a customer acquisition cost (CAC)—spend to acquire one customer—to the customer's lifetime value (LTV)—revenue made from a customer over his entire period with a business—ratio of 1:3 or better. Need to explain CAC and LTV
8. Elevator Pitch:
It is a short brief for the potential customers, investors and industry specialists to get interested in the idea behind the product or company. The goal is to convey the overall concept in an exciting way. The name—elevator pitch—reflects the idea that it should be delivered in the time span of an elevator ride, roughly one minute. If you are looking to craft an elevator pitch, you may find these examples helpful.
9. Lead Investor
An investor who first comes in and invests the highest amount of capital among the investors in the startup for substantial ownership. They represent the investors of the startup before, during and after a fundraise.
The lead investor acts as a link between the fundraising startup and the investors. They usually get a seat on the board of directors and help the company raise the next round of capital.
The lead investor should ideally be a subject matter expert in the domain the startup is operating in or have engaged with the startup for some time to understand the nuances of the business.
10. Convertible Note
A convertible note is a short-term debt that can convert into equity in future, often in conjunction with the subsequent funding round. It is issued to angel or seed investors for investing in early-stage companies which could not establish their valuation yet.
Since the investor takes a high risk by investing at an early stage, they are given additional benefits on top of interest for the loan. These benefits are given in the form of a valuation cap, discount to the next round valuation or both during the conversion event.
11. Angel Investor:
An angel investor is a high-net-worth individual who provides funds to the small or early-stage startups in pre-seed and seed stages. They generally invest in the form of convertible notes, which later get converted into equity.
A super angel is an angel investor who aggressively invests large amounts of money in early-stage companies.
Equity represents ownership and shows how much control a person has over the decisions of the company. There are two forms of equity: common stock and preferred stock. Common stock is a security that represents the ownership of a company. Common stockholders get voting rights.
Most investors prefer preferred stocks due to their higher liquidation preference. Preferred stock shareholders get preference in a claim on the company assets at the time of liquidation. Preferred stocks also give investors certain rights which are not offered to other shareholders.
Employee stock option plan refers to an employee benefit plan under which a company grants stock options to its employees. Companies use ESOPs to attract and retain talent by allowing their employees to purchase shares of the Company at a price fixed on the grant date.
Most institutional investors ask founders to create an ESOP pool before their investment . This is done to make sure that key hiring can take place without their equity dilution. Qapita digitises the entire process of granting and administrating ESOPs.
Warrant gives the holder the right to buy a company's equity at a specified price during a specific period. The warrant holder makes an upside as the share price increases. Though anyone can hold warrants, they are mostly given to venture debt investors to provide additional returns .