Incorporation – the process by which a business receives a state charter, allowing it to become a corporation. Many corporations choose Delaware because its laws are business-friendly and up to date.
Incubator – a company or facility designed to host startup companies. Incubators help startups grow while controlling costs by offering networks of contacts and shared backoffice resources.
Indemnities – clauses often included in sale and purchase agreements that establish circumstances under which, post-completion, the vendor will be required to pay the purchaser sufficient funds to cover certain losses or damages in relation to the target company, usually with limits on value and scope. These tend to be specific in nature; for example, if the company operates on contaminated land, the seller may grant an indemnity that if the EPA requires the acquirer to decontaminate the site within a specified timeframe, the vendor will pay the acquirer funds sufficient to meet the clean-up costs, most likely to a pre-determined maximum limit.
Indenture – the terms and conditions between a bond issuer and bond buyers.
Initial public offering (IPO) – the first offering of stock by a company to the public. New public offerings must be registered with the Securities and Exchange Commission. An IPO is one of the methods that a startup that has achieved significant success can use to raise additional capital for further growth. See Qualified IPO.
In-kind distribution – a distribution to limited partners of a private equity fund that is in the form of publicly traded shares rather than cash.
Inside round – a round of financing in which the investors are the same investors as the previous round. An inside round raises liability issues since the valuation of the company has no third party verification in the form of an outside investor. In addition, the terms of the inside round may be considered self-dealing if they are onerous to any set of shareholders or if the investors give themselves additional preferential rights.
Institutional investor – professional entities that invest capital on behalf of companies or individuals. Examples are: pension plans, insurance companies and university endowments.
Intellectual property (IP) – knowledge, techniques, writings and images that are intangible but often protected by law via patents, copyrights, and trademarks.
Internal rate of return (IRR) – the interest rate at which a certain amount of capital today would have to be invested in order to grow to a specific value at a specific time in the future.
Investment thesis / Investment philosophy – the fundamental ideas which determine the types of investments that an investment fund will choose in order to achieve its financial goals.
IPEV – International Private Equity and Venture Capital, a body established by AFIC, BVCA and EVCA, which includes a Valuations Board that produces valuation guidelines for private equity and venture capital firms.
Issuer – the company that chooses to distribute a portion of its stock to the public.
J curve – a concept that during the first few years of a private equity fund, cash flow or returns are negative due to investments, losses, and expenses, but as investments produce results the cash flow or returns trend upward. A graph of cash flow or returns versus time would then resemble the letter “J”.
Later stage – the state of a company that has proven its concept, achieved significant revenues compared to its competition, and is approaching cash flow break even or positive net income. Typically, a later stage company is about 6 to 12 months away from a liquidity event such as an IPO or buyout. The rate of return for venture capitalists that invest in later stage, less risky ventures is lower than in earlier stage ventures.
Lead investor – the venture capital investor that makes the largest investment in a financing round and manages the documentation and closing of that round. The lead investor sets the price per share of the financing round, thereby determining the valuation of the company.
Letter of intent – a document confirming the intent of a buyer and seller in a transaction or the intent of an investor to participate in a round of financing for a company. By signing this document, the subject company agrees to begin the legal and due diligence process prior to the closing of the transaction.
Leverage – the use of debt to acquire assets, build operations and increase revenues. By using debt, a company is attempting to achieve results faster than if it only used its cash available from pre-leverage operations. The risk is that the increase in assets and revenues does not generate sufficient net income and cash flow to pay the interest costs of the debt.
Leverage ratios – measurements of a company’s debt as a multiple of cash flow. Typical leverage ratios include Total Debt / EBITDA, Total Debt / (EBITDA minus Capital Expenditures), and Senior Debt / EBITDA.
Leveraged buyout (LBO) – the purchase of a company or a business unit of a company by an outside investor using mostly borrowed capital.
Leveraged recapitalization – the reorganization of a company’s capital structure resulting in more debt added to the balance sheet. Private equity funds can recapitalize a portfolio company and then direct the company to issue a one-time dividend to equity investors. This is often done when the company is performing well financially and the debt markets are expanding.
License – a contract in which a patent owner grants to a company the right to make, use or sell an invention under certain circumstances and for compensation.
Limited liability company (LLC) – an ownership structure designed to limit the founders’ losses to the amount of their investment. An LLC does not pay taxes, rather its owners pay taxes on their proportion of the LLC profits at their individual tax rates.
Limited partner (LP) – an investor in a limited partnership. The general partner is liable for the actions of the partnership while the limited partners are generally protected from legal actions and any losses beyond their original investment. The limited partner receives income, capital gains and tax benefits.
Limited partnership – a legal entity composed of a general partner and various limited partners. The general partner manages the investments and is liable for the actions of the partnership while the limited partners are generally protected from legal actions and any losses beyond their original investment. The general partner receives a management fee and a percentage of profits (see Carried interest), while the limited partners receive income, capital gains and tax benefits.
Liquidation – the sale of a company. This may occur in the context of an acquisition by a larger company or in the context of selling off all assets prior to cessation of operations (Chapter 7 bankruptcy). In a liquidation, the claims of secured and unsecured creditors, bondholders and preferred stockholders take precedence over common stockholders.
Liquidation preference – the contractual right of an investor to priority in receiving the proceeds from the liquidation of a company. For example, a venture capital investor with a “2x liquidation preference” has the right to receive two times its original investment upon liquidation.
Liquidity discount – a decrease in the value of a private company compared to the value of a similar but publicly traded company. Since an investor in a private company cannot readily sell his or her investment, the shares in the private company must be valued less than a comparable public company.
Liquidity event – a transaction whereby owners of a significant portion of the shares of a private company sell their shares in exchange for cash or shares in another, usually larger company. For example, an IPO is a liquidity event.
Lock-up agreement – investors, management and employees often agree not to sell their shares for a specific time period after an IPO, usually 6 to 12 months. By avoiding large sales of its stock, the company has time to build interest among potential buyers of its shares.
London Interbank Offered Rate (L.I.B.O.R.) – the average rate charged by large banks in London for loans to each other. LIBOR is a relatively volatile rate and is typically quoted in maturities of one month, three months, six months and one year.
Management buyout (MBO) – a leveraged buyout controlled by the members of the management team of a company or a division. Often an MBO is conducted in partnership with a buyout fund.
Management fee – a fee charged to the limited partners in a fund by the general partner. Management fees in a private equity fund usually range from 0.75% to 3% of capital under management, depending on the type and size of fund. For venture capital funds, 2% is typical.
Management rights – the rights often required by a venture capitalist as part of the agreement to invest in a company. The venture capitalist has the right to consult with management on key operational issues, attend board meetings and review information about the company’s financial situation.
Market capitalization – the value of a publicly traded company as determined by multiplying the number of shares outstanding by the current price per share.
Mezzanine – a layer of financing that has intermediate priority (seniority) in the capital structure of a company. For example, mezzanine debt has lower priority than senior debt but usually has a higher interest rate and often includes warrants. In venture capital, a mezzanine round is generally the round of financing that is designed to help a company have enough resources to reach an IPO. See Bridge financing.
Milestones – operational or financial goals of a company that are often used to determine whether a company will receive additional financing or whether management will receive additional compensation.
Multiples – a valuation methodology that compares public and private companies in terms of a ratio of value to an operations figure such as revenue or net income. This includes both comparable quoted multiples (where a publicly traded company with similar characteristics is used as a valuation benchmark) and comparable transaction multiples (where historic transactions for entire publicly traded or private companies are used as a valuation benchmark). For example, if several publicly traded computer hardware companies are valued at approximately 2 times revenues, then it is reasonable to assume that a startup computer hardware company that is growing fast has the potential to achieve a valuation of 2 times its revenues.
Narrow-based weighted average anti-dilution – a type of anti-dilution mechanism. A weighted average ratchet adjusts downward the price per share of the preferred stock of investor A due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A’s preferred stock is repriced to a weighed average of investor A’s price and investor B’s price. A narrow-based ratchet uses only common stock outstanding in the denominator of the formula for determining the new weighted average price.
Negative pledge – a contractual obligation given by a borrower to its lender not to do something, such as using an asset for security for any further loans.
Net operating income (NOI) – a measure of cash flow that excludes the effects of financing decisions. NOI is calculated as earnings before interest and taxes multiplied by one minus the tax rate. Also known as Net operating profit after taxes.
No-shop clause – a section of an agreement to purchase a company whereby the seller agrees not to market the company to other potential buyers for a specific time period.
Non-compete – an agreement often signed by employees and management whereby they agree not to work for competitor companies or form a new competitor company within a certain time period after termination of employment.
Non-cumulative dividends – dividends that are payable to owners of preferred stock at a specific point in time only if there is sufficient cash flow available after all company expenses have been paid. If cash flow is insufficient, the owners of the preferred stock will not receive the dividends owed for that time period and will have to wait until the board of directors declares another set of dividends.
Non-disclosure agreement (NDA) – an agreement issued by entrepreneurs to protect the privacy of their ideas when disclosing those ideas to third parties.
Non-interference – an agreement often signed by employees and management whereby they agree not to interfere with the company’s relationships with employees, clients, suppliers and sub-contractors within a certain time period after termination of employment.
Non-solicitation – an agreement often signed by employees and management whereby they agree not to solicit other employees of the company regarding job opportunities.
NVCA – National Venture Capital Association, the trade organization that tracks venture capital activity in the United States.
Operating cash flow – the cash flow produced from the operation of a business, not from investing activities (such as selling assets) or financing activities (such as issuing debt). Calculated as net operating income (NOI) plus depreciation.
Optics – the way a concept is presented. Sometimes entrepreneurs’ presentations are strong on optics but weak in content.
Option pool – a group of options set aside for long term, phased compensation to management and employees.
Original issue discount (OID) – a discount from par value of a bond or debt-like instrument. In structuring a private equity transaction, the use of a preferred stock with liquidation preference or other clauses that guarantee a fixed payment in the future can potentially create adverse tax consequences. The IRS views this cash flow stream as, in essence, a zero coupon bond upon which tax payments are due yearly based on “phantom income” imputed from the difference between the original investment and “guaranteed” eventual payout. Although complex, the solution is to include enough clauses in the investment agreements to create the possibility of a material change in the cash flows of owners of the preferred stock under different scenarios of events such as a buyout, dissolution or IPO.
Orphan – a startup company that does not have a venture capitalist as an investor.
Outstanding shares – the total amount of common shares of a company, not including treasury stock, convertible preferred stock, warrants and options.
Oversubscription – when demand exceeds supply for shares of an IPO or a private placement.