Tag Archive for: venture capital

Top 15 VC (Venture Capital) Terms Every Founder Needs to Know

By Ellie Pigott

1. Liquidation Preference

Liquidation Preference refers to the order of which the investors in the company get paid in the event the company goes under. Typically the order is as follows; senior debt (long term loans- commercial banks, etc.), subordinated debt (seed funds, angel investor, venture capitalist and friends/family), preferred stock (investors other than the founder), and lastly common stock (founders and employees).  

 2. Deal Flow 

Deal flow describes the rate at which new investment opportunities are being presented to a company. Typically deal flow is evaluated quarterly but can be broken down and measured month to month or week by week. If a firm is experiencing high deal flow, this can make the environment more competitive for startups and make it more challenging to get a deal.  

 3. LOI (Letter of Intent)  

An LOI or Letter of Intent, is used in the later stage of a deal process. These documents can be very broad or in some cases very detailed. The more detailed LOIs outline what a deal would look like and present the terms for both parties to agree on. A VC will offer this document to a startup they’re pursuing and once the terms can be agreed on and signed, the firm will begin the process to move the deal to close.  

 4. Terms Sheet 

Similar to the LOI, the term sheet outlines the specifics of the deal. Depending on the depth on the LOI, the terms sheet may include a lot of the same information. A terms sheet will include details on equity, liquidation, board structure, dividends and more.

5. Pre Money vs Post Money Valuation  

Pre Money valuation is the value of the company before the investment is made. This number is typically negotiated between the VC and the startup, as it helps to determine what percent equity the VC firm will receive. Post Money Valuation is the value of the company after the investment (pre money value + investment amount = post money value). For example, if a startup is valued at $1.5 million before the investment, and a firm invests $1 million, the pre money value is $1.5 million and the post money value is $2.5 million. When calculating ownership of the company, VC’s will base their ownership on the post money valuation.  

 6. Burn Rate  

Burn Rate refers to the rate at which a company deploys their capital. To calculate burn you can take your starting balance – existing balance / your number of months. Although burn rates vary depending on industry, a general rule of thumb is to keep your burn rate near 1/12 of your available cash. Ensuring you have enough cash on hand to make it through the year.  

7. Churn Rate  

Churn is often used with SaaS companies and apps, as it refers to the customers they’re losing at a monthly or annual rate and the associated revenue being lost. For an existing company, 6-8% annual churn is average, but for startups an average annual churn is closer to 45% (which breaks down to about 7% monthly). 

 8. Bootstrapping  

Bootstrapping is slang for being completely self-funded, or “pulling oneself up by one’s bootstraps,” meaning building the business from the ground up only using personal or family funds. This can also be shown through the flexing of personal skills and knowledge to build the business with existing resources.  

 9 . Convertible Note 

A convertible note, otherwise known as convertible debt, begins as debt in the form of a loan from an investor and later is converted to equity. The number of shares received depends on the amount of the loan, plus interest that has accrued, and whether a conversion discount is in place. A conversion discount would allow the investor to purchase the shares at a cheaper price than the current valuation, giving them an incentive for loaning money at an earlier stage. This form of financing can help the deal move quicker while also helping to avoid fees on either party (investor or investee).  

 10. Due Diligence  

Due diligence is the research done by the VC firm before investing in the company. This can be done at multiple stages in the process, and will typically include research on competitors, founder experience, traction and more. Due diligence in the later stages of a deal process will also include more financial and legal vetting.  

11. Down Round  

A down round refers to an additional raise after the previous use of funds did not yield the expected performance, or there was a change in the market. Since the company did not perform as well as expected, this next round of shares will be sold at a cheaper price. This can be seen with early startups who set their valuations too high and can range all the way to highly successful and established startups whose growth has slowed after increasing at an exponential rate. A down round is viewed as negative by prior investors as their investment has now been “marked down” or decreased in value. It is important to have the “right” priced valuations to avoid a down round.  

 12. EBIT/EBITDA Multiple 

EBIT and EBITA stand for Earnings Before Interest, Tax, Depreciation and Amortization. When determining a company’s trajectory from a growth standpoint and a return on investment perspective, the EBIT/EBITDA multiple can determine its value. The multiple used can be calculated in a variety of different ways including taking the enterprise value divided by EBIT, or by looking at the multiples of companies in the same industry or who use the same model. EBIT/EBITDA is typically used in more mature companies raising funds or exiting, as opposed to earlier stage companies raising a Seed or Series A round and may still be burning cash and not yet profitable. 

 13. Entrepreneur in Residence  

An entrepreneur in residence is an individual with experience successfully running a business, who supplies a startup with advice and knowledge on how to help their company. This can be done as a hired mentor or even make the entrepreneur in residence the temporary CEO. In the case of becoming the temporary CEO, the EIR is usually brought on by a VC firm either at the time of the investment or acquisition.  

 14. Use of Capital 

Use of capital is exactly what it sounds like, it describes how the capital will be used. This is extremely important when talking to investors because they want to know that you have a plan for using their funds in an effective manner. This can be a variety of things but the most common are growing the team through hiring, investing in building out the platform or product, scaling production, etc.  

 15. Option Pool 

Option pool describes the set of shares set aside for current and future employees. Giving key employees a small share in the company is often done as part of their employment package because startups typically cannot afford larger salaries. This helps startups remain competitive with larger companies who may be able to offer higher employment compensation.  

 

If you or someone you know is interested in raising capital, reach out to us at peyton@tractioncapital.com. In addition, be sure to watch our Resources page for future blogs and startup events.  

Top 10 VC (Venture Capital) Terms Every Investor Needs to Know

By Ellie Pigott

1.  Limited Partner (LP)

Limited Partner (otherwise referred to as an LP), is the term for an investor who is a member of the fund. This means they have agreed to the terms of the fund, and thus are investing their money but do not have control over the management of the fund. 

2. General Partner (GP)

The General Partner is in charge of managing the money in the fund. This person is both an investor and a full-time employee of the fund. They oversee raising the capital and make the decisions where to allocate it. Although the GP does have the most say or control in a fund, in most cases they are still governed by a board which helps to approve the highest cost decisions or commitments made above a certain threshold. 

3. PortCo 

Like many terms in VC, portco is an abbreviation. Portco, otherwise known as a portfolio company, is a company that the fund has invested into. Many VCs have a portfolio page on their website where you can gain more info on the success of their portcos. If you can’t find a public portfolio of a VC you’re looking to invest in, ask if they can provide you with a few examples. 

4. Cap Call (Capital Call)

When someone agrees to be a limited partner in the fund, they agree to contribute a certain amount of money. However, this money is usually not taken all at once, but instead in (often) pre-determined increments over the life of the fund. A cap call is the term used for the announcement and collection of that predetermined amount. Because LP’s sign contracts agreeing to the terms of the fund, these cap calls can be enforced by law.  

5. Committed Capital

As mentioned in the definition of cap call, the committed capital is the amount an LP signs on to contribute to the fund. Committed Capital is the total amount the LP is contributing, and funds will almost always have a minimum amount of committed capital required to participate in the fund. 

6. IRR (Internal Rate of Return)

Projected IRR or Internal Rate of Return is an equation used to calculate how profitable an investment may be. This equation tracks both time and cash flow to determine annual growth for the investment. Since Committed Capital is called over time and not paid in all at once, IRR is typically higher with Capital Calls than if Committed Capital is paid all up front. 

7. Sidecar (SPV)

A sidecar or otherwise referred to as a special purpose vehicle, is used to raise additional capital for a PortCo with a small pool of investors. SPV’s are run by the same lead investor as the existing capital. Investors who have already invested in the existing capital through the VC fund are also eligible to contribute additional capital in the sidecar. These types of SPV’s are typically raised because the Portco has a growth need arise or because the lead investor is not covering the entirety of the raise. 

8. Carry

Carry is the term for the percentage of the profits the General Partner receives, in addition to a small management fee. The profits help the GP to cover overhead costs to help run the fund. For example, paying their team who helps identify new portcos and manage existing ones. Carry also helps incentivize good performance for the GP. Carry is typically not paid to the GP until all principal investments have been returned to the LP.  

9. Accredited Investor

To become an accredited investor, you need special designation achieved by meeting certain financial regulation criteria. There are different requirements depending on the investment, and to qualify, they may take into account your gross income, net worth, asset size, and professional experience. Being accredited means you need less protection by the SEC and it allows you to engage in investment activities not registered with financial agencies. 

10. Management Fee

A management fee is a fee charged to LPs to manage their investment in the fund. This fee is annual but is typically taken out during the cap calls. Each fund can determine their individual management rate but most charge between 2-3%. This fee helps account for operational cost and the diligence that goes into each of the investments.  

If you or someone you know is interested in raising capital or you’re interested in investing options like private equity or venture capital, reach out to us at peyton@tractioncapital.com. In addition, be sure to watch our Resources page for info regarding our potential investor events! 

5 Types of Alternative Investing

By Ellie Pigott

For many, when they hear the word investing, they think of the stock market, retirement funds or maybe even crypto. But the possibilities don’t stop there. For those whose lifestyle can allow a less liquid investment vehicle, alternative investing is a great option. There are several vehicles to choose from including private equity, venture capital, angel, real estate, storage unit investments and more.

Here are several investment vehicles we have come across.

1. Private Equity

While private equity takes many forms, the overarching definition is investing in private companies either directly or through a fund. This can be done to gain shares of the company or to acquire the company.

Unlike the stock market, these investments have very long holding periods. Private equity firms typically exit between 3-5 years, but investors can expect waiting up to 10 years for their return.

Over the last 20 years, returns in private equity have averaged higher than that of the S&P 500. The current average PE return in the U.S is just above 10%.

2. Venture Capital

One of the many forms of PE is Venture Capital. This investment vehicle still invests in private companies but the companies receiving investments are startups with large potential for growth.

As opposed to the start-up going to the bank to receive a loan or running a crowdfunding campaign, the VC option provides the startup with both capital and expertise.

This can be extremely beneficial to entrepreneurs, especially those who lack industry knowledge in a certain area. For example, if the founder has a great vision for the company but doesn’t know much about accounting and finance, the VC firm would help fill that knowledge gap.

VC funds are typically 10 year hold periods that can extend to 12 years depending on their needs. Investors become Limited Partners (LP) in the fund and can experience tax benefits such as 1202 stock treatment, reducing overall tax liability.

VC Fund managers act on behalf of the fund to source investment opportunities, perform due diligence on companies and founders, and assist startups to growth and eventually exit.

At Traction Capital, we help connect investors with our portfolio companies that are directly related to their expertise. For some this can be mentorship, a board seat, or more, depending on the investor’s level of interest and availability.

3. Angel Investing

Similar to Venture Capital, Angels also invest in startups. This type of alternative investing is for individuals with high net worth, who provide the funds directly to the company. In most cases the capital is in exchange for equity of the company.

Because such high capital is needed, Angels typically need to become an accredited investor before investing. This ensures a level of stability and prohibits just anyone from claiming to be an Angel.

As opposed to a VC or PE fund, where a firm is doing the due diligence, this type of investment normally requires your own time and research.  To spread their risk, many Angels invest in several startups at the same time, across various industries.

Another way Angels lower their risk is by going in on a deal with multiple angels. This requires a network of trusted, well backed individuals. There are Angel networks for investors to join, some which provide deal flow, industry experience and educational opportunities.

4. Real Estate

During the pandemic the real estate market skyrocketed, but even prior, the market had been consistently climbing. Over the last 10 years the market has grown an average of 5% year after year, not including 2021, in which the market grew 17%.

Across the board, annual rate of return in real-estate has averaged 10% over the past 10 years. Investing in real estate can take many forms.

The more hands-on forms include owning a rental property or flipping a house. However, if you are looking for a hands off vehicle where your money can grow over time, a Real Estate Investment Trust, Mutual Fund, Limited Partnership, or Investment Group might be a better fit.

REITs are publicly traded shares of a commercial real estate company that owns many properties. In a Real Estate Investment Group, you buy into the fund by purchasing property, that property is then managed by the investment group. Lastly, a Real Estate Mutual Fund is an investment vehicle requiring less capital. This type of fund is more liquid, as they primarily invest in REITs, instead of purchasing property.

5. Storage Unit Investments

Just as VC is a division of PE, Storage Unit Investments are a division of Real Estate. There are several ways to go about investing in a storage facility, the main three being REITs, Self-Storage Syndicate and buying a property.

The first is the least risky and arguably requires the least amount of day-to-day work. Because REITs are publicly traded, they have strict regulations that help protect against fraud. Like any REIT, storage unit investments are great for consistent growth over a long period of time.

The second option is a syndicate. This allows investors to pool their money with other investors to purchase a facility that would then be managed by the sponsor of the fund. Like a VC fund, the investors would be LP’s, with basically no liquidity, but high potential returns.

The third option is to buy the storage unit facility and manage it yourself. Although the profits are consistently climbing, this requires a lot of upfront capital, as well as management knowledge. This option also requires the most hands-on work, as opposed to the others, which allow your money to sit and grow over time.

Next Steps

With so many alternative investing options, deciding on the right one can be challenging, confusing, and time consuming. If your lifestyle can allow illiquidity, alternative investing is a great way to not only diversify your portfolio, but to get involved with a founder or project that you enjoy and can help grow. The most important thing to keep in mind with any of the options is history and legitimacy of whatever investment vehicle you choose. Always be sure to do your research and collect all relevant data before committing any capital.

Traction Capital is a private equity and venture capital firm based near the Twin Cities. Unique from others in our industry, our entire team is made up of entrepreneurs.

As a team full of entrepreneurs that have successfully run and exited companies, we are well equipped to advise and assist our portfolio founders with any challenges that might arise.

If you or someone you know is interested in raising capital or you’re interested in alternative investing options like private equity or venture capital, reach out to us at peyton@tractioncapital.com. In addition, be sure to watch our Resources page for info regarding our potential investor events!