Learn the language of fundraising—without getting your MBA
When you look into fundraising for your business, it can a feel a bit like learning a foreign language. Discounts? Liquidation preferences? Tranches? What on earth are those?!
I remember one of my first meetings with venture capitalists—when they asked what my gross margins were, my brain totally froze. Luckily, my mouth was still working and I was able to say, “I’ll have to get back to you on that.” I knew what my margins were, but were gross margins the same thing?
The jargon used in the investing industry can be pretty off-putting for those of us who don’t have a background in finance. But I founded a language teaching company and I’ll share a little secret: You don’t have to become fluent in investor language to secure funds. You just need to be conversational. This means you need to able to provide a set of answers, ask the right questions and hold your own in investment conversations. It’s not as hard as it might seem.
Most people are intimidated by fundraising, so you are not alone. Instead of being struck with the paralyzing fear of the unknown, I want you to be able to sit down with investors and confidently hold your own. That’s why I’m using this blog to highlight some of the most common terms and answer some of the most common questions women entrepreneurs who want to fundraise need to know.
Angel investors vs. venture capitalists
I’m starting here because it’s likely you’ll be starting your fundraising efforts with angels who may even be family and/or friends. You may eventually move on to venture capitalists if you have the kind of business that is scalable and can provide a big return (think 5-10X) in 5-7 years.
Angels are high net worth individuals who see investment in your business as a potentially rewarding opportunity and use their own money to make the investment.
Venture capitalists are firms that use other people’s money. They raise funds by offering investors a chance to be a part of a fund that is subsequently used to buy shares in your company.
Margins vs. gross margins (they were different!)
While both types of margins are key indicators of your company’s financial health, one gives investors the “big picture” overview of your profit and revenue while the other accounts for how much of your profit goes to expenses.
Gross margin is the percentage of total sales revenue that your company keeps after subtracting the cost of producing your goods and/or services. Essentially, the higher the percentage, the more money you keep on each dollar of sales.
Standard margin is the balance that remains after your company’s standard costs are deducted from your sales.
Equity financing vs Debt financing
Equity financing is the amount of funding you’ve obtained from investors in exchange for ownership of your company. While you could offer shares of your company to family, friends or other small investors, equity financing is generally involves angel investors or venture capitalists. (Think of the folks on Shark Tank.)
Debt financing will probably sound a lot more familiar because it’s a lot like buying a home or using a credit card. You borrow money from a person or business and pledge to pay it back with interest, but you don’t actually give up any ownership or control.
Valuation: Pre-money vs post-money
Valuation is the monetary value of your company. Pre-money is the value of your company before you receive funding. Post valuation is the sum of your pre-money valuation and new funding. So if you’re pre-money valuation is $15M and someone invests $5M, your post money valuation would be $20M.
Convertible debt (AKA: convertible notes)
It can be tough to give a young company fair valuation, so when an investor agrees to convertible debt, you’re able to secure funds while delaying valuation until your company is more mature. So while it’s technically still debt, it converts to equity at a later date—usually a subsequent round of funding. Just keep in mind that the investor may expect warrants or a discount as a reward for investing their money at the earliest, and therefore riskiest, stages of your business.
Uncapped and capped notes
Directly related to convertible debt, where valuation is delayed until a later funding round, capped and uncapped notes describe the round of funding.
A capped round means the valuation at which investors’ notes convert to equity has some kind of ceiling, which can give investors high ownership in the business. An uncapped round is often preferred by entrepreneurs because investors get no guarantee of how much equity their money is purchasing.
Preferred stock and liquidation preference
The goal of any financing company is an eventual payday—or liquidation event—where everyone with a stake in the company has the chance to cash out. The most common types are acquisitions, IPOs and ulp, to be avoided, bankruptcy.
So when a VC firm is given stock in your company, it’s usually preferred stock (instead of common stock), which comes with certain rights for the investor. One of these is liquidation preferences, which determines who gets paid what and when during a liquidation event. The payout is often:
- Creditors first
- Preferred stock owners second
- Common stock owners last
The standard liquidation preference is 1x, which means that anyone owning preferred stock must get their money back before common stock holders get anything.
The bottom line is truly the “bottom line” when it comes to your business and your profitability. It is your net profits or losses after all other financial information has been calculated.
And the bottom line here is that you can learn enough to hold your own in any investing conversation—no MBA required. And if you’re ever not sure, don’t panic! Just say, “I’ll have to get back to you on that” and keep going.