Common Terms in the Tech Startup Space for Lawyers to be Familiar With
Every field has its technical terms that outsiders or new entrants always have difficulties relating to, even though the meanings of these terms may not be unfamiliar. The tech startup space has its share of these terms. However, many of these terms did not originate with the tech startup space. Many were borrowed from private equity, investment banking, and similar fields.
I have highlighted some of these terms here for lawyers who are trying to make the jump to the startup space or lawyers who are new entrants into the space and are facing challenges relating to these terms, like I did.
The list is not exhaustive and I will be publishing them in series. So, let’s call this the first of the series. Also, in order to make this as brief as possible, the explanations will be succinct with examples where necessary.
So, let’s go!
1. Cap Table
Fully known as capitalization table, cap table is a table showing the total shareholdings of the company with all necessary details depending on the company. Generally, cap table contains the name of each shareholder, its number of shares, class of shares, percentage of shares etc. A typical cap table looks like this:
Shareholder / No. of Shares / % of Shares / Class of Shares
- Kurunmi Kola / 500,000 / 50% / Ordinary Shares
2. XYZ Ltd / 300,000 / 30% / Ordinary Shares
3. ABC Ltd / 200,000 / 20% / Preference Shares
Total / 1,000,000 / 100%
*This was initially done in a table but the table could not be transferred to Medium.
Valuation is the total worth of a company at a given time. Valuation of a company is very important, especially for fundraise. The valuation determines the price of a share and the number of shares to be allotted to the investor. Diverse methods are used in arriving at the valuation of a company but it has been agreed in the startup space that valuation is not necessarily scientific.
3. Pre-money Valuation
Simply called ‘pre-money’, pre-money valuation is the valuation of a company prior to a fundraise. If an investor wants to invest $5 Million in a company whose initial valuation is $10 Million. The pre-money is $10 Million.
4. Post-money Valuation
Also, simply called ‘post-money’, the post-money valuation of a company is the valuation after an investment. Using the example in (3) above, the post-money valuation of the company is $15 Million.
5. Term Sheet
Term Sheet is more like a memorandum of understanding between a proposed investor and an entrepreneur. It is a non-binding document that contains the initial terms of an investment as agreed between the investor and entrepreneur or company or as proposed by an investor. The content depends on the fact of each investment but it can contain terms such as amount of the investment, the valuation of the company, the number of shares to be allotted to the investor, the number of Board seats the investor is entitled to, etc. The Term Sheet obtains its binding force from the execution of the substantive investment documents.
6. Convertible Note / Debt
A Convertible Note / Debt is a financing instrument that is a hybrid of both debt and equity. It is a debt that is convertible to an equity in a company, which is why it is called a ‘Convertible’ Note. As a debt, it can be repaid with agreed interest at maturity or can be converted to shares in the company at an equity financing round or as may be agreed between the parties in the Note.
SAFE, meaning Simple Agreement for Future Equity, is also a financing instrument where an investor invests money in a company but rather than be allotted shares in the company immediately, the shares are allotted at a future time. The future time is generally called a ‘priced round’ which is an investment round where the investment is based on the valuation of the company, price of the shares, and shares are to be allotted to the investor(s).
8. Down Round
This is a financing round circumstance where the valuation at which a company is raising funds is lower than the valuation of the last financing round. For instance, a company raised funds at a valuation of $10 Million in 2021. If it raises funds at a valuation of $8 Million in 2022, that is a ‘down round’.
9. Primary Sale
This is a sale of shares to investors whereby the Company issues new shares or unallotted shares to the investors. If a company has 1,000,000 share capital but 500,000 are unissued, if the company issues the 500,000 shares or part of it to new investors, that is a primary sale.
10. Secondary Sale
As opposed to primary sale, a secondary sale is where the investor buys shares of the company from existing shareholders. Using the cap table example in (1) above, if an investor called JFK Ltd buys 100,000 shares from the 200,000 shares held by ABC Ltd, that is a secondary sale.
The Second Series will be published soon. In order to be notified when it goes live, kindly click the “follow” button. Also, sometime in December 2021, I published a guide on how lawyers can make the jump from a traditional law firm to the tech space. You can read it here.