The world of Venture Capital (VC) can be confusing. Despite being a multi-billion dollar industry that powers the creation and development of the products, brands and services we interact with every day, the concept of venture capital isn’t well understood by those outside of the startup and investment community. In recent polling commissioned by the Newton Venture Program, we found that a huge 94% of the British public wouldn’t be able to confidently describe what venture capital is.
We must close this education gap and ensure more people understand VC and the role it plays in our economy. If we’re able to do that, we can start to attract people from more diverse walks of life into investment roles, which in turn will help boost the numbers of founders from overlooked and underestimated backgrounds securing investment. That’s the idea behind our newly launched foundations course; a free learning programme to help people get to grips with the basics of venture capital.
We often hear that there are so many different terms and phrases thrown around in VC that it confuses, even for people working in or around the startup space. This knowledge gap can be intimidating and the available explanations can cause more confusion rather than clarity. To help build your knowledge, here are five of the more confusing VC terms and what they mean:
Cap table:
This term is actually short for ‘capitalisation table’. This refers to the list of people (either individual investors or institutions such as VC funds) who have put money into a startup. It also shows how much of the business they own. By exchanging money – or ‘capital’ if we’re using the fancy term – for a shareholding in a startup, these investors are taking on different-sized portions of ownership in a business. Every time a startup raises a new round of investment, the cap table will shift around; new names will be added, some will leave, and the ownership percentage will change. Think of the cap table as a record of who invested what, when, and what portion of the company they got in exchange.
Dilution:
Every time a startup raises money from investors, the more slices of company ownership a founder has to give away. Let’s say a company is launched by two founders. On day one, they own 50% of the company each. But they decide to take some VC investment and the VC wants 10% of the company in exchange for £500,000. That means the founders now only own 45% of the company each. This cycle continues with every new investor that joins the cap table.
The upside for the founder? As their company grows and becomes more valuable, each share is worth more. That 50% on day one is essentially worthless. However, 45% of the company five years later might be worth millions. As founder shares dilute, what they retain is, in theory, going up in value.
Secondaries / secondary sale:
You might hear people in the industry referring to secondaries, or a secondary sale. This is when existing shareholders (often those who invested in the startup at an early stage), sell their stake to new investors. This is helpful for those investors, who can exchange their stake or share of the company for money without waiting for a startup to ‘exit’ (i.e. get acquired or have an Initial Public Offering (IPO)). Secondaries can also be useful for founders, as it means they can re-sell their existing shares in the business, rather than create more shares to attract new investors.
Lots of early-stage investors, such as angel or pre-seed investors, sell their shares via a secondary sale when the startup raises Series A or Series B funding.
Convertible notes:
When money moves from VCs to startups, it’s normally a straight swap: cash for shares (otherwise known as ‘equity’). However, a convertible note is different. A convertible note is a loan from an investor to a startup. The startup either pays that loan back over time (plus interest) or offers the investor the opportunity to turn the investment into shares in the company at a later date (normally when a pre-agreed milestone is hit, such as the next funding round).
This is a more flexible arrangement for both investors and startups and can be a useful form of funding when startups are either super early-stage or need some additional capital in between funding rounds.
Carry:
Most people working in venture capital earn a good salary. But they stand to make huge amounts of additional money if their investments succeed through something called ‘carry’ ‘carried interest’ is its full name).
Typically reserved for the more senior members of a VC fund (such as partners, general partners, or senior associates), carry is like a performance-based bonus. If a VC fund generates good returns through its investments, the first people to benefit are the fund’s limited partners (LPs – the people who invest in the VC funds). Once the LPs have been paid back, the remaining capital is shared between the partners or senior colleagues at the VC fund. This is carry. It works as an incentive for the fund and encourages teams to make bold decisions that will deliver big returns.
Read the orginal article: https://www.eu-startups.com/2024/04/the-abcs-of-vc-5-confusing-vc-terms-and-what-they-mean/
