Common Terms in the Tech Startup Space for Lawyers to be Familiar With — II

On 31 May, I started this series to help lawyers who desire to transition or who newly transitioned to the tech space to get more familiar with common terms they would hear or come across in the tech startup space. This is the second edition of the series. If you missed the first, you can read it here.

So, let’s get into it!

11. Venture Capital

Venture capital is the funds invested by a firm called a venture capital or VC firm or a venture capitalist in a startup company. Most VC firms pull funds together from limited partners (LPs) and invest in startups with high growth potential and return the funds to the LPs with returns upon exit from the startups. It is to be noted that most investors know that investing in startups is a risky venture. So, an investment may go bad and investors lose their funds or the company may succeed and investors get high returns on their investment.

12. Angel Investor

Angel investors are individuals or high net-worth individuals (HNIs) who mostly invest their own money in startups. They may be families, friends, or even strangers.

13. Seed Round

This, like other similar terms, is the stage a company is in when it is seeking to raise funds. A seed stage company is one where the company is building its minimum viable product to take to the market. At this stage, the entrepreneur has the idea, is already building the idea into a sellable product and is looking for the initial funding to sustain that process. Other rounds that a company can name its financing round include pre-seed, pre-Series A, Series A, Series B etc., which all signify the different stages of growth or development a company is. However, financing rounds are no longer cast in stone and a company can name its financing round as it deems fit.

14. Bridge funding

A bridge is a short-term funding that a company is raising to sustain its operations till the next financing round. It can be through a debt funding or through any of the other investment instruments listed in the first series.

15. Burn Rate

This is the amount of money a startup uses within a given timeframe for its operations. It is the operating expenditure a company deploys within a month, a year, or howsoever measured, to facilitate its operations.

16. Runway

This is how long the burn rate of a company can last for it to stay afloat and continue operations till it requires another funding. For instance, if a company spends the sum of $500k every month on its operations and it has $2m in the bank, it means the company’s burn rate is $500k per month and its runway is 4 months.

17. Flat Round

This is in relation to “down round” that was mentioned in the first series. It is a financing round where the valuation at which a fundraise is done is the same valuation that the last fundraise was done. If a company raised funds in 2021 at a valuation of $10m and it raises funds in 2022 at the same valuation of $10m, the fundraise in 2022 is a flat round.

18. Dataroom

This is like a repository of information about a company which it shares with a potential investor. It is mostly hosted on the cloud and it contains all the key information about a company which would help the potential investor have a detailed view of the company. Dataroom generally contains the information of a company relating to its business, corporate formation, employees, intellectual property, finances, its prior investments etc. Access to a company’s dataroom should be on a need-to-know basis with necessary non-confidential and non-disclosure agreement signed.

19. Employee Stock Option (ESOP)

This is a pool of shares set aside to be issued to employees (or key employees) of the company. Most companies set aside up to 10% of its shares to be issued to its employees and some investors include it as part of their investment terms. The rationale for the employee stock option is for the employees to have a sense of belonging and ownership in the company and to be able to drive the company to profitability. There are different parameters that different companies use in determining the employees who participate in the stock option while some companies allow all employees benefit from the stock option.

20. Vesting Period

Vesting period is the length of period, at times with attached milestones, it takes for the shares allotted to an individual, mostly employees, to be fully owned by the individual. Shares allotted to an employee from the stock option do not immediately become fully owned by the employee. It mostly vests over a period of time which is mostly between 3 to 4 years. A vesting period also includes a cliff period which is the period where none of the shares will vest in the employee if such an employee leaves the company within that period. For instance, JMK Ltd allots 1,000 shares to Kay Kay, its employee, with a vesting period of 4 years, 1-year cliff, and the shares are to vest in equal instalments. This means, for the first year, none of the shares will vest in Kay Kay (this is the cliff period). At the end of the first year, if Kay Kay is still an employee of the company, 25% (250) of the shares will fully become Kay Kay’s. At the end of the second year, another 25% will become Kay Kay’s till the fourth year, if he remains an employee of the company. If Kay Kay leaves the company at any time before the 4th year, the shares will be prorated till the time he leaves the company and allotted accordingly.