As you continue your journey into the world of angel investing, understanding venture capital terminology is key to navigating deals with confidence. Whether you're evaluating investment opportunities or reviewing term sheets, having a firm grasp of the jargon will empower you to make informed decisions. In this post, we'll break down some essential venture capital terms and concepts that every angel investor should know.
1. Term Sheet
A term sheet is a non-binding agreement that outlines the key terms and conditions of an investment. It serves as a blueprint for the formal investment agreement, detailing the valuation, percentage of ownership, and any investor rights. While not legally binding, a term sheet reflects the mutual understanding between the startup and the investor.
2. Valuation
Valuation refers to the estimated worth of a startup. It's a critical figure that determines how much equity an investor will receive for their investment. There are two main types of valuation to be familiar with:
Pre-Money Valuation: The company’s value before receiving outside investment.
Post-Money Valuation: The company’s value after receiving investment. This is calculated by adding the investment amount to the pre-money valuation.
3. Equity
Equity represents ownership in a company. When you invest in exchange for equity, you become a shareholder, which entitles you to a portion of the startup's profits and, depending on the type of equity, may include voting rights on important decisions.
4. Instrument/Security
An investment instrument or security is the vehicle used to structure the deal. Here are some common types you’ll encounter:
Convertible Note: A short-term debt that converts into equity at a future financing round, often at a discounted rate. It accrues interest and has a maturity date.
Straight Equity: A direct investment in exchange for shares, giving the investor immediate ownership and often voting rights.
KISS Note (Keep It Simple Security): A convertible debt instrument designed to be straightforward and startup-friendly, with fewer legal complexities than a traditional convertible note.
SAFE Note (Simple Agreement for Future Equity): Similar to a convertible note, but it doesn't accrue interest and has no maturity date. It grants the investor rights to future equity when the company raises its next round.
5. Special Purpose Vehicle (SPV)
An SPV is a legal entity created solely for a specific investment. Investors can pool their money through an SPV to invest in a single startup. This structure can simplify the investment process and offer certain legal and tax benefits for both the investors and the startup.
6. Dilution
Dilution occurs when a company issues additional shares to raise capital, reducing the percentage of ownership held by existing shareholders. As a company grows and raises more funding, dilution is a natural part of the process, but it’s important to understand how it impacts your equity stake.
Mastering these terms will help you speak the language of venture capital, making it easier to evaluate deals, communicate with founders, and protect your investments. Understanding the nuances of valuation, equity, and investment instruments is essential as you build your portfolio of high-potential startups.
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