Sheltowee Business Network Blog

Raising Capital:  Understanding Key Terms & Financing Approaches

Raising Capital: Understanding Key Terms & Financing Approaches

Jul 19 2019

Raising Capital:  Understanding Key Terms & Financing Approaches

By Dawn Yankeelov

As we enter the workforce, there is a presumption that we are old enough to understand everything there is to know about money.  As an entrepreneur launching a new business, you begin to appreciate that this is simply not a given; we must work for the knowledge we need to succeed.

The fundraising process for an entrepreneur seems straightforward at a glance:  (a) come up with an idea; (b) develop a plan; (c) develop a pitch; (d) pitch your plan (e) get someone interested; (g) go through due diligence; and (h) close the deal.  Let’s not forget assembling your team to get the business up and running—for which you may need some or most of your dollars. 

However you must understand the different types of funding; the types of people that could potentially invest; the inherent risks of being in deals with these people; and the lexicon of terms associated with raising capital.

Below is a quick primer overview with key definitions, provided by Sheltowee Business Network Founder & CEO Alex Day, with support from Wikipedia, and other resources.  He has designed a workshop format, both live and online, that allows for a deeper dive into these subjects when you are ready.  Find live and e-learning opportunities for this fee-based workshop and online course at www.sheltowee.com.  See Business-In-A-Box.

Types of Investors

At the most basic level, you have friends, family and perhaps some, deemed in jest, “fools” (those willing to take the risk without knowing you or the team directly, or perhaps not really understanding the concept, but liking something about your pitch); qualified angel investors; venture capital types; and crowdfunding types. 

General Funding

The general options include bootstrapping, grants, debt including credit cards and other banking loans, as well as equity options including venture dollars, and crowdfunding.

Key Fundraising Terms

Besides articles of basic organization and incorporation, and operating agreements, there are terms like convertible notes, term sheets, preferred equity, full ratchet, weighted ratchet, cap tables, SAFE (Simple Agreement for Future Equity), and the business valuation, to name a few.

Let’s take a high level pass at some of these definitions:

Term Sheets—This will include a key investor and negotiation, equity, a valuation, and closing terms.  A term sheet ends up being the document outlining the terms and conditions of a business agreement. After a term sheet has been executed, it guides legal counsel in the preparation of a final agreement.

Convertible Note--A convertible note is a form of short-term debt that converts into equity, typically tied to a round of future financing.  The investor loans money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.

Preferred Equity--Preferred equity is a general term used to describe any class of securities (stock, limited liability units, limited partnership interests) that has higher priority for distributions of a company's cash flow or profits than common equity.

Full Ratchet—This is an anti-dilution provision meaning that in essence, after the issuing of a convertible security, the lowest sale price is the adjusted option price or conversion ratio for existing shareholders.

Weighted Ratchet-- Weighted average anti-dilution protection gives consideration to the relationship between the total shares outstanding as compared to the shares held by the original investor.

Cap Tables-- A capitalization table is a table providing an analysis of a company's percentages of ownership, equity dilution, and value of equity in each round of investment by founders, investors, and other owners.

SAFE (Simple Agreement for Future Equity)-- In practice, a SAFE enables a startup company and an investor to accomplish much of what a convertible note does, though a SAFE is not a debt instrument.

Business Valuation--Business valuation is a strategic process and procedures used to estimate the economic value of an owner's interest in a business. 

Having gone through these terms, suffice to say that deal terms can vary greatly and are to be negotiated by the parties involved.

Of course, before going down the path of investment, early questions to ask yourself and your team as an entrepreneur will go to the overall market size, scope, and your intended approach to reaching the intended target audience of your product or service. 

Alex Day, Founder and CEO of the Sheltowee Business Network, makes the point in his seminars that investors from different parts of the US choose to invest differently and have different styles. Step 1 remains understanding the financial terms, and knowing what you need to fulfill on your vision and mission to get out of the idea phase and into test marketing.  

Attend a Sheltowee Business Network meetup to find like-minded types, consultants, subject matter experts, and angels and consider paid membership for access to the network’s resources.  Find the network events listed in Eventbrite and at www.sheltowee.com.

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