50 Terms You Need To Know In pre-IPO Investing
Navigating the pre-IPO investment landscape requires a deep understanding of specific terminology underpinning the processes, strategies, and legal frameworks. This glossary, encompassing 50 crucial terms, serves as a foundational guide for investors aiming to explore opportunities in companies before they become publicly traded. It covers the financial instruments, investor rights, company equity structures, and regulatory considerations essential for making informed decisions and maximizing the potential for returns in the pre-IPO domain.
50 terms you need to know in pre-IPO investing:
Accredited Investor
An individual or a business entity can trade securities not registered with financial authorities. They are recognized based on their net worth, income, assets, or professional experience.
Angel Investor
An affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity.
Bridge Financing
Short-term funding provides a company with immediate capital until it can secure a longer-term solution. They often bridge the gap to the next financing round or an expected liquidity event.
Cap Table (Capitalization Table)
A spreadsheet or table showing a company's equity capitalization lists all company securities, such as common equity shares, preferred equity shares, and warrants, and who owns them.
Carry (Carried Interest)
A share of the profits investment managers receive as compensation is typically a percentage of the profits earned by a fund or an investment vehicle. This is a performance fee rewarding the manager for enhancing performance.
Common Stock
Common stock is a type of equity ownership in a corporation that typically carries voting rights and represents a claim on a portion of the company's profits (dividends). In liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders, and other debt holders are paid in full.
Convertible Note
A form of short-term debt that converts into equity, typically in conjunction with a future financing round. It is a common financial instrument used in early-stage venture financing.
Data Room
A secure, online database where companies and startups store, manage and share essential documents during due diligence processes, usually related to fundraising or M&A activities.
Dilution Protection
Provisions that protect investors from equity dilution in future financing rounds, ensuring that their ownership percentage is not significantly reduced. These provisions often allow investors to purchase additional shares later to maintain their ownership percentage.
Down Round
A financing event where a company raises capital at a lower valuation than in previous financing rounds, often resulting in significant dilution for existing shareholders.
Drag-Along Rights
A provision that allows majority shareholders to force minority shareholders to join in the sale of a company. It ensures that a minority group cannot block a sale that is in the interest of the majority.
Due Diligence
The investigation or exercise of care that a reasonable business or person is expected to take before entering into an agreement or contract with another party or an act with a certain standard of care.
Entry Fee
A charge that investors pay when they join or invest in a fund. In the context of pre-IPO investing, this fee might cover the costs associated with due diligence, legal fees, and setting up the investment structure. Entry fees are less common in traditional venture capital or private equity funds but may be encountered in other investment vehicles designed for retail or non-accredited investors.
Equity Crowdfunding
A mechanism that enables broad groups of investors to fund startup companies and small businesses in return for equity.
Exit Strategy
How an investor or a business owner intends to exit their investment in a company. Common exit strategies include IPOs, acquisitions, or buyouts.
Initial Public Offering (IPO)
The process through which a private company becomes a publicly traded company by offering its shares for sale to the general public for the first time.
Interest
The investor's title is in the SPV—a portion of the SPV proportional to their investment.
IRR (Internal Rate of Return)
A discount rate is a metric used in capital budgeting to estimate the profitability of potential investments. It makes the net present value (NPV) of all cash flows from a particular project equal to zero.
K-1 (Form K-1)
A tax form used in the United States to report the incomes, losses, and dividends of a partnership or an S corporation's shareholders. It is filed with the IRS.
Lead Investor
The individual or entity that organizes and leads a round of financing, often contributing the largest share of capital, conducting due diligence, negotiating terms, and liaising between the company and other investors.
Liquidation Preferences
Terms in a contract that dictates the payout order in the event of a corporate liquidation. Typically, preferred stockholders have rights to be paid before common stockholders.
Liquidity Event
An IPO is a common liquidity event that allows early investors in a company to sell their shares.
Lock-Up Period
The period post-IPO during which insiders and early investors are restricted from selling their shares. Typically, it lasts from 90 to 180 days after the IPO, depending on the type of IPO the company goes for. The period can be found in the S-1 filing.
Management Fee
A fee paid by investors in a fund to the fund's management team for the operations and administration of the investment fund. It is typically a percentage of the fund's assets under management (AUM) and is charged annually.
Minimum Investment
An investor must invest the smallest amount of money to participate in a specific investment opportunity. In pre-IPO and venture capital investments, this amount can vary significantly depending on the fund, investment vehicle, or direct investment opportunity. It is set to ensure that investors are sufficiently committed and to manage the administrative burden of having a large number of investors.
Non-Disclosure Agreement (NDA)
A legal contract between at least two parties that outlines confidential material, knowledge, or information that the parties wish to share for specific purposes but want to restrict access to or by third parties.
Pitch
A presentation by founders to potential investors to raise money for their business. It typically includes the business plan, model, market opportunity, team, and financial projections.
Post-Money Valuation
The valuation of a company immediately after the latest round of financing. This amount equals the pre-money valuation plus the amount of new equity.
Pre-IPO
Refers to the phase in a company's life cycle before it offers shares to the public through an Initial Public Offering (IPO).
Pre-Money Valuation
The valuation of a company before an investment or financing. If an investment adds cash to a company, the company plans to use the money for future growth.
Preferred Stock
A type of stock entitles holders to a fixed dividend, whose payment takes priority over common stock dividends. Holders of preferred stock generally do not have voting rights. Preferred stock often has features like convertibility into common stock and priority over common stock in asset liquidation.
Primary Round
A financing round in which new company shares are created and sold to investors, directly increasing the company's capital.
Private Equity
Capital investment is made into companies that are not publicly traded. Investors buy stakes in private companies intending to earn returns through eventual exits such as IPOs or sales.
Private Placement
A means of raising capital by selling securities to a relatively small number of select investors to raise capital without going public.
Pro Rata Rights
Investors have the right to participate in future financing rounds to maintain their percentage of ownership in the company. These rights are often negotiated at the time of investment.
Qualified Purchaser
An individual or family-owned business that owns $5 million or more in investments, as defined under the United States Investment Company Act of 1940. This classification allows participation in certain investment funds not registered with the SEC.
ROFR (Right of First Refusal)
A contractual right that gives its holder the option to enter a business transaction with the owner of something, according to specified terms, before the owner is entitled to enter into that transaction with a third party. In pre-IPO investing, this often applies to shares, where existing investors or the company have the right to buy shares before offering them to another party.
SAFE (Simple Agreement for Future Equity)
An investment contract between a startup company and investors that provides rights to the investor for future equity in the company without determining a specific price per share at the time of the initial investment. It is intended to be simpler and more cost-effective than convertible notes.
Secondary Market
A market where investors purchase securities or assets from other investors rather than from issuing companies themselves. In the context of pre-IPO investing, this refers to the buying and selling of a company's private shares before it goes public.
Series LLC
A unique form of a limited liability company that allows for the creation of multiple series or cells within a single LLC, each of which can have its members, managers, assets, and interests separate from the other series within the same company.
Share Dilution
A decrease in the company's existing shareholders' ownership percentage is due to the company issuing more shares, often through fundraising rounds.
SPV (Special Purpose Vehicle)
A subsidiary company created to isolate financial risk. In pre-IPO investing, an SPV is often used to pool investor funds to invest in a private company, thereby simplifying the investment process and management for both the investors and the company.
SPV Manager
An individual or entity responsible for managing a Special Purpose Vehicle (SPV). The manager handles administrative responsibilities, including compliance, investments, and distributions related to the SPV.
Syndicate
A syndicate is a group of investors who come together to invest in a venture, often led by a lead investor or investment firm. Syndicates allow individuals or entities to pool their resources to invest in larger opportunities, sharing the risks and rewards.
Tag-Along Rights
Rights that allow minority shareholders to sell their shares in the event that a majority shareholder sells theirs ensure that minority shareholders can exit the company under similar conditions as the majority.
Term Sheet
A non-binding agreement outlining the basic terms and conditions under which an investment will be made. It serves as a template for more detailed, legally binding documents.
Transfer Agent
Financial institution or a trusted company appointed by a corporation to manage the record-keeping and processing of investor transactions, including the issuance and transfer of the company's stocks
Valuation
The process of determining the current worth of a company or its assets. In pre-IPO investing, this refers to how much the company is worth before it goes public.
Vesting Schedule
There is a timetable for when employees or founders can claim full ownership of their granted equity. This timetable is designed to incentivize longevity and commitment to the company.
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Disclaimer
Private companies carry inherent risks and may not be suitable for all investors. The information provided in this article is for informational purposes only and should not be construed as investment advice. Always conduct thorough research and seek professional financial guidance before making investment decisions.
