Startup Glossary: What Are Investments, Convertible Loans And Term Sheets?

In the first part of ur un-alphabetical but logical glossary, we focused on terms you will encounter when you first enter the world of startups. Today we will dwell on the second stage of your startup life – thinking about how on Earth you will finance your newly started business.

Bootstrapping

Bootstrapping usually refers to the starting of a self-sustaining process that is supposed to proceed without external input – this means you rely on your own cash stash. Your savings, other income, your mom still giving you allowance, whatever makes you get through another work day.

Etymologically, the originated in the early 19th century United States, from the phrase ”pull oneself over a fence by one’s bootstraps”, which basically describes an absurdly impossible action – however, it is not that impossible, and there are some fairly good reasons to fuel your business by bootstrapping – and there is a whole post focused on those reasons on the .Me blog!

Seed Investment

If you don’t decide to bootstrap, but rather choose a different path and seek for an investment, this is what you’re looking (asking?) for. This is the first investment (sometimes the only investment) you’ll get and it is meant to support the business until it can generate cash of its own, or until it is ready for further investments (called Series A).

This can include your friends and family funding who are willing to throw some money your way in exchange for equity, angel funding, accelerator investments and those made by investment funds – by the way, this exchange of money for equity is called equity investment.

Seed-stage investing hasn’t been very popular in the past, because it’s pretty risky, but it has lately experienced a boom – in North America, seed funds now represent 67% of all VC funds.

Here’s a cool infographic by FoundersFounders which breaks down investments:

Convertible Debt

Sometimes you won’t be offered an equity investment, but a convertible loan instead. This is short-term debt that turns into converts into equity and is most often offered in early stages of the startup lifecycle. A convertible loan has a maturity date when the investor can convert the loan into an equity stake in the company.

It has much less terms than an equity investments, and it can be executed faster, in a couple of weeks. On the other hand, it’s a loan – if you don’t have enough cash to repay the loan by the maturity date and turning the loan into equity doesn’t seem like an attractive option to the investor, they have the right to claim any assets. Basically, take your cash and hardware to repay the debt.

This is a good option in some cases, but take it with a grain of salt and weigh your option carefully – as you hopefully would with just about any funding option.

Term Sheet

Whether you’re getting an investment or a convertible loan, you will be presented with a term sheet. This is a non-binding summary of key terms, that is exclusive and confidential.

Confidentiality means you can’t share it with anyone besides the investors who presented you with the term sheet and that you should not discuss the terms with anyone who has not signed it.

Exclusivity means you can’t negotiate with other investors for a specified period of time. Both apply only when you sign the term sheet.

The term sheet is not binding – it’s there for you to see what you get, under what terms and what you give in return, and it is signed before the actual transaction (paperwork signing)

Valuation

Valuation is one of the terms in your term sheet, and it is basically the monetary value of your company. How much your company’s worth. That’s a bit tricky when you’re not yet making ay money, when it comes to seed investments, for example.

There is pre-money valuation and post-money valuation: Pre-money is your company’s value before receiving funding, whereas post-money valuation is your pre-money valuation + new funding

They way you calculate the pre-money valuation is looking at the expenses you have and estimating how long it will take you to get to the next stage.

Had enough? We’ll stop here this week, and talk about some itty-gritty terms in the next post.