Standard Terms in Non-Public Financing Transactions (A-F)
The following are some standard terms that are used in financing transactions for start-up and other pre-IPO ventures.
| Accredited Investor | An investor who meets certain financial and other criteria specified in SEC Regulation D. Examples of accredited investors include (1) individuals with a net worth of $1,000,000 or more or (2) individuals who have had net income of $200,000 during the previous two years and expect to have net income in excess of that amount during the present year. |
| Angel Investor | An individual who invests in start-up and other pre-IPO companies. Investments by angels are generally comparatively small (less than $1,000,000). Angels are often contrasted with venture capitalists, which are usually professionally managed funds whose investments are larger. |
| Anti-Dilution Clauses | Provide an investor with a means of protecting that investor’s percentage ownership interest if the company issues additional stock. These clauses generally take two forms: (1) one adjusts the number of shares of common stock into which the investor’s preferred stock will convert if the company issues stock at a lower price than that paid by the investor; and (2) the other makes adjustments to the conversion ratio if the number of shares of stock of a company is increased after a stock split, stock dividend or similar change in the company’s stock. See also “Full Ratchet Anti-Dilution Clause” and “Weighted Average Anti-Dilution Clause.” |
| Authorized Shares | The number of shares of stock a company is permitted to issue under its charter. This is distinguished from “issued and outstanding shares,” which are defined below. |
| Best Efforts Underwriting | A contractual arrangement through which an underwriter agrees to use its best efforts to sell stock in a public offering, but is not legally bound to purchase or sell any specific number of shares. Generally used in smaller public offerings. (See “Underwriter” and “Firm Commitment Underwriting”). |
| Blue Sky Laws | State (as opposed to federal) laws relating to the regulation of securities. |
| Bridge Financing | A short-term financing, usually in a relatively small amount, designed to provide the company with sufficient funds to operate until the next major round of equity financing. Bridge financing is generally in the form of short-term debt that is paid off when the major equity financing is received or in the form of convertible debt. |
| Common Stock | Stock that does not have liquidation or dividend preferences over any other class of stock. In start-ups, common stock is usually issued to founders, employees, directors and other service providers. |
| Conversion Rights | The right of a shareholder or note holder to convert his, her or its stock or note into another form of security. For example, a right to convert preferred stock into common stock or a right to convert a debt security (such as a note) into stock. |
| Convertible Debt | Debt securities that convert into stock upon the occurrence of certain events and/or at the election of the holder. |
| Convertible Preferred | Preferred stock that converts into common stock upon the occurrence of certain events (such as an initial public offering) and/or at the election of the holder. |
| Corporation | A type of business organization. Other types of business organizations include limited liability companies, general partnerships and limited partnerships. The corporate form is most common for businesses that seek angel or venture capital financing. |
| Co-Sale Rights | The right of an investor to require that an outside buyer purchase the investor’s stock if another shareholder, such as a founder, sells his or her stock to that buyer. Also known as “Tag Along” rights. |
| Dividend Preference | The right of the holders of preferred stock to receive payment of a specified amount from the company as a dividend before the company may pay dividends to the holders of common stock. (See also “Liquidation Preferences”). |
| Drag-Along Rights | The right of an investor to require a shareholder (usually a management or founding shareholder) to agree in advance to a sale of the company to a third party if the investor approves of the sale of the company. |
| Firm Commitment Underwriting | A contractual arrangement in which the underwriter commits to purchase a specified number of shares of stock in a public offering. |
| Full Ratchet Anti-Dilution Clause | A provision in the statement of the rights of holders of convertible stock or warrants that adjusts the conversion price to the lowest price at which shares are issued in the future. For example, assume preferred stock is initially issued at $1.00 per share and is convertible into one share of common stock. If the issuer subsequently sells shares for $0.50 per share, the conversion price for the preferred stock will be reduced to $0.50 per share, which will result in each share of preferred stock being convertible into two shares of common stock. Full Ratchet anti-dilution provisions are significantly more favorable to investors and much less favorable to issuers and holders of common stock than Weighted Average anti-dilution provisions. |
| Fully-Diluted Basis | A calculation of the number of issued shares of stock of a company which assumes that all convertible securities have been converted and that all options and warrants have been exercised in full. |