10 Key Finance Terms for Entrepreneurs
Successfully raising capital for a new venture is extremely difficult. Initially, friends and family may form a significant component of investment, but approaching more serious investors for larger amounts of capital is a very different process. One of the many challenges a new entrepreneur must face is understanding a whole new vocabulary. Young entrepreneurs run the risk at appearing inexperienced and missing investors if they fail to use financing terms correctly. Worse yet, savvy investors can take advantage of entrepreneurs who do not understand the agreements they’re signing. Fortunately there many great resources available to learn.
African Leadership Academy’s Entrepreneurial Leadership curriculum requires students to study and understand these terms as a component of their business education. See below for an initial ten words essential for anyone navigating entrepreneurial finance to understand:
- Debt – refers to money borrowed from institutional investors and paid back with interest.
- Equity – refers to issued shares of a company sold to investors for capital or issued to employees. When a firm sells equity to obtain capital, there is no repayment required, but selling equity adjusts firm ownership which can impact how decisions are made.
- Convertible Notes / Convertible Debt – refers to a financing method in which an investor agrees to lend money to an entrepreneur upon certain conditions. The investor reserves the right to convert the debt into equity should the venture meet certain stated thresholds. This type of financing can be more available because the investor bears less risk.
- Angel Investor – individuals or groups interested in investing in very early stage ventures, typically in return for equity. These individuals often enjoy serving as mentors and advisors to entrepreneurs.
- Venture Capital – investment groups who invest in equity of early stage ventures with high growth potential, seeking to capitalize on returns from these high-risk investments. This type of finance typically comes after angel investors.
- Series A – the first round of venture capital funding conducted by a venture, referring to the set of equity sold to investors in exchange for investment. Further rounds are referred to as Series B, C, etc.
- Term-sheet – the document that outlines the agreement by which an investor makes financial investments in the firm, often including details on the funding, corporate governance, and liquidation terms. It typically covers how much is received, the decision-making influence of the investor, and how the investor can exit.
- Cap Table – a capitalization table details the equity ownership of the firm by each founder and investor, detailing the value of equity at each round of investment.
- Come (Drag)-along / Tag-along Rights – these terms refer to what happens if your investor decides to exit. A drag along right indicates that the majority investor can force a minority party to sell in negotiations along the same terms as the majority. A tag along right indicates the right of a minority shareholder to join a sale along the same terms.
- Valuation – the process of determining the current value of a company; many techniques are used to provide these estimates. For early stage ventures, valuations can be imprecise and investors are likely to assign their own values.
Being knowledgeable in financing is essential to combine with your confidence in your new venture for success in obtaining capital. This list is by no means comprehensive. Continue reading and studying up on entrepreneurship to ensure that you stand out from the competition.