The glossary of essential terms to master when raising funds
Fundraising is a crucial step for any startup looking for growth. However, it comes with a technical vocabulary that can sometimes seem intimidating. To navigate this world with peace of mind, it is essential to understand the key terms that punctuate the process. In this article, we explore the essential concepts by illustrating them with real-world examples.
Pre-Money and Post-Money Valuation
The pre-money valuation corresponds to the value of a startup before the contribution of a new investment. For example, if a startup is estimated at €5 million before a fundraising, this value constitutes its pre-money valuation. On the other hand, the post-money valuation includes the amount invested. Thus, if an investor contributes €2 million, the post-money valuation becomes €7 million (5 + 2). These concepts have a direct impact on the distribution of the company's shares, influencing governance and investors' return potential.
Term Sheet (LOI)
The term sheet is a preliminary, non-binding document that outlines the agreement between the investors and the founders. It covers elements such as valuation, investment structure, and the rights of the parties. For example, a term sheet may stipulate that an investor will inject €1 million in exchange for 20% of the capital, while providing for specific voting rights. Although not definitive, it serves as a basis for the final negotiations.
Cap Table (Capitalization Table)
The cap table is a table detailing the distribution of a company's capital among founders, investors, and other stakeholders. It includes the percentages of ownership, the amounts invested and the associated rights. For example, a cap table might indicate that the founders own 60% of the shares, while two investors hold 25% and 15% respectively after a fundraising.
Due Diligence
Due diligence is a thorough audit conducted by investors to assess the viability of the startup. This includes reviewing financial statements, contracts, patents, and potential risks. For example, an investor wishing to finance a technology startup could analyze whether the intellectual property is well protected. This process reduces uncertainty before making a financial commitment.
Burn Rate
The burn rate represents the rate at which a startup consumes its cash to cover its expenses. For example, if a startup spends €50,000 per month and has €200,000 in cash, its runway is four months. This calculation is essential to assess the financial viability of the business.
Milestones and Investment Tranches
Milestones are key milestones defined in the context of an investment. For example, a startup could receive 50% of the funds raised at signing, and then the balance when it reaches a specific goal (e.g., acquisition of 1,000 customers). This allows investors to limit risks by conditioning their financial commitment on the company's actual performance.
Bridge Loan
A bridge loan is a bridge loan granted to a startup to provide it with liquidity before a fundraising or significant income inflow. For example, a business angel can grant a €100,000 bridge loan, repayable in capital or convertible into shares at the next round.
SPV (Special Purpose Vehicle)
An SPV is a legal entity created specifically to bring together several investors in the same investment vehicle. This mechanism is often used by business angels to simplify relationships with startups, reduce administrative costs, and structure the investment efficiently. For example, a network of business angels could create an SPV to invest €500,000 in a startup, with each member of the network contributing a proportional share. The SPV then acts as a single investor in the startup's table.
Protection Clauses
Protection clauses, like anti-dilution clauses, are intended to protect investors from adverse situations. Let's say a startup raises new funds at a lower valuation than the previous one (downround). An anti-dilution clause would allow the initial investor to retain an equivalent share in the capital, reducing the impact of the valuation decline.
These clauses, inserted in the shareholders' agreement or investment agreements, aim to protect the interests of business angels:
Anti-dilution clause : Protects investors if a future fundraising is done at a lower valuation (downround).
Example : An investor who has bought 10% of shares can keep his percentage in the event of dilution thanks to this clause.
Liquidation Preference Clause : Ensures that investors recover their initial investment (and sometimes a multiple) before other shareholders in a sale or liquidation.
Example : An investor who has injected €500,000 will be able to recover this sum before the founders or other shareholders receive anything.
Vesting : A mechanism that distributes the allocation of shares to founders or employees over a given period, often linked to their commitment to the company.
Example : A co-founder will receive his shares gradually over 4 years, with an initial vesting period of 12 months (cliff).
Drag-Along : Allows majority shareholders to force the sale of minority shares if a global buyout opportunity arises.
Tag-Along : Gives minority investors the right to sell their shares under the same conditions as majority shareholders.
Equity Gap
The equity gap refers to the difficulty for some startups to raise funds due to a lack of investors willing to take risks in their sector or at their stage of development. This phenomenon is particularly marked for start-ups in seed stages or those in highly innovative fields such as deeptech. Business angels play a key role in bridging this gap and providing the necessary funds before venture capital funds intervene.
Financial Instruments : Convertible Bonds and BSPCEs
Convertible bonds allow investors to lend funds to the startup, with the option to convert this loan into shares at a later date, often in a future fundraising. This limits risk while providing an opportunity to profit from growth. The Warrants for the Subscription of Shares of Business Creators (BSPCE), on the other hand, are tools used to attract and retain talent. These bonds allow you to buy shares at a fixed price, often lower than their future value, thus offering a high potential for capital gains.
BSA-AIR (Share Subscription Warrants - Rapid Investment Agreement)
BSA-AIR are hybrid financial instruments specially designed to simplify and accelerate seed fundraising. This mechanism allows an investor to receive bonds which, in the long term, can be converted into shares at a predetermined price or according to a discount applied during a future fundraising. For example, an early-stage startup can issue BSA-AIR to raise €200,000, allowing investors to enter the capital at a favourable price when an official valuation is established at a later date.
The main interest of the BSA-AIR lies in their simplicity of use and their reduced legal cost, avoiding the long negotiation processes of a shareholders' agreement for the first rounds. However, they carry risks, especially for investors, as the conversion price remains uncertain until the next round of funding. This model is particularly suitable for startups looking to raise funds quickly to finance their initial development or reach an initial strategic milestone.
IR-PME (Tax Reduction for SMEs)
The IR-PME scheme allows investors to benefit from an income tax reduction equivalent to 25% of the amount invested in an eligible SME. For example, if a business angel invests €10,000 in an innovative startup, they can reduce their tax by €2,500, provided they keep their shares for at least five years. It is a powerful tax tool to encourage investment in companies in the growth phase.
Preferential Liquidation
Liquidation preference is a clause that ensures that an investor recovers their initial investment before any other shareholder in the event of liquidation or resale of the company. For example, if a startup is sold for €5 million, an investor who has invested €1 million could receive this sum in priority before the rest is distributed among the other shareholders.
Drag-Along et Tag-Along
Already mentioned above, the drag-along and tag-along clauses govern the rights of sale. The first allows majority investors to force other shareholders to sell their shares in the event of an opportunity. For example, if a large company offers to buy 100% of the startup, the majority investors can involve the minority investors in this sale. Conversely, the tag-along clause protects minority shareholders by allowing them to participate in a sale initiated by the majority shareholders.
Buy-Back Rights
The buyability of shares is a clause that allows the founders or the company to buy back shares from an investor under certain conditions. For example, a startup may include a clause to buy back an investor's shares if they want to exit before a strategic fundraising. This ensures stability in the cap table.
Exit
The exit represents the exit of investors, the moment when they recover their investment, often with a profit. This can be done via an acquisition, an initial public offering (IPO), or a buyout by the founders. For example, if an investor has taken 20% of a startup valued at €10 million, and the latter is sold for €50 million, the investor realizes a significant return on his investment.
Closing
The closing marks the finalization of the investment, where all the conditions are met to secure the agreement between investors and startup. This step begins with the lifting of the conditions precedent (dispute resolution, obtaining patents, etc.), before the signing of the investment protocol, which sets out the financial commitments and the rights of the parties.
Financial instruments such as convertible bonds or BSA-AIR allow the investment to be structured flexibly, offering options for conversion into shares depending on the progress of the startup. Protective clauses, such as anti-dilution or liquidation preference, increase investors' security against unforeseen events.
Once the formalities are completed, the final legal documents are registered, formalizing the new capital structure. The closing, more than a formality, guarantees a solid foundation to protect investors while allowing the startup to develop in a secure and transparent framework.
This glossary is just an overview of the essential terms when raising funds. Mastering this vocabulary is essential to engage effectively with investors, negotiate favourable terms and maximise the chances of success. Whether you are an entrepreneur or a business angel, a good understanding of these concepts will allow you to navigate the complex but exciting world of fundraising with confidence.
