Here's what the most common terms actually mean.
An independent third-party appraisal of the fair market value of the company's common stock. Among other uses, a 409A Valuation is typically relied upon to determine the exercise price of stock options awarded to service providers. A 409A Valuation may be valid for up to 12 months provided that material events such as a new funding round or significant business change renders it stale.
A tax filing that a holder of stock subject to vesting can use to immediately pay income tax on the difference between the price paid and the fair market value of that stock. Without this filing, the holder is taxed on the spread as each share vests. The filing may only be made within 30 days of the grant date, no exceptions. Any future appreciation in value, assuming a filing is timely made, is taxed as capital gains rather than ordinary income.
A provision that causes unvested equity to vest ahead of schedule upon a specified triggering event. The two most common forms are (1) single trigger acceleration, where vesting accelerates upon a change of control alone, and (2) double trigger acceleration, where acceleration occurs only if both a change of control and an involuntary termination happen within a specified window.
A federal tax system designed to ensure that taxpayers pay a minimum amount of tax where their tax liability would otherwise be lower under the income tax system. The 'spread' between the exercise price and the fair market value of incentive stock options (ISOs) at exercise is an AMT adjustment item. Exercising ISOs after significant appreciation in a company's value relative to when the ISO was granted can create a substantial AMT liability.
Provisions in the company's Certificate of Incorporation intended to offset the dilutive effect of certain new issuances of stock by adjusting the ratio at which an investor's preferred stock converts into common stock.
The most common (most founder-friendly) type of price-based anti-dilution protection. The conversion ratio of preferred stock is proportionally reduced by a formula based on the price per share of new stock, and the 'broad-based' denominator includes common stock issuable upon conversion of options and warrants, resulting in a smaller, more founder-friendly adjustment.
A constitutional document for the company (subordinate to the certificate of incorporation) that generally sets out the procedural rules governing the company, including director elections, board and stockholder meetings, and officer appointments.
A capitalization table, or 'cap table,' lists all of the company's securities (including common stock, preferred stock, options, and warrants), the holders of those securities, and the percentage of the company owned by each holder on both an issued and fully diluted basis.
The gains realized when a capital asset is sold for more than its original cost. Long-term capital gains (on assets held more than one year at the time of sale) are taxed at preferential rates, typically significantly lower than ordinary income rates. Short-term capital gains (on assets held no more than one year at the time of sale) are generally taxed at ordinary income rates. Long-term capital gains treatment is potentially available to anyone who becomes an owner of the company, whether through founder stock, restricted stock, or option exercises, and additional tax advantages may be available (for example, Qualified Small Business Stock (QSBS)).
The primary constitutional document for the company. Includes provisions dealing with authorizing the stock issuable by the company, establishing the rights, preferences and privileges of the classes and series of stock authorized, and determining what matters stockholders can vote on.
Generally occurs when a company is acquired by or merged into another entity, or when a majority of the voting power of the company changes hands.
A provision often in Promissory Notes dictating that if the company undergoes a Change of Control while the note is outstanding, the holder is repaid the principal plus accrued interest, plus an additional premium payment, often some multiple of the original principal.
Popularized by the Founder's Institute, this is a type of common stock held by founders that provides super-voting power (e.g., 10 votes per share vs. 1 vote for regular common stock). The goal is to enable founders to continuously issue shares to investors while keeping voting control.
A minimum service period following the grant of an equity award prior to any vesting. It is typical for equity awards with a four-year total vesting schedule to be subject to a one-year cliff, such that 25% of the award vests when the cliff lapses.
Conditions that must be satisfied (or waived) before parties close a financing, e.g., before investors wire investment funds in exchange for stock. Examples include legal opinions, appointment of new board members, and filing of an amended Certificate of Incorporation.
The basic equity ownership interest in a corporation, typically held by founders and service providers. Common stock typicall carries voting and dividend rights and participates in company value after all liquidation preferences are satisfied. In a venture-backed company, investors generally hold preferred stock with superior economic rights to common stock.
The agreement employees of a company sign agreeing to confidentiality obligations and to assign the intellectual property created by that employee to the Company. This can also be referred to as a Proprietary Information and Inventions Agreement.
A discount (typically expressed as a percentage) off the price per share of stock issued in a Qualified Financing, used to calculate the number of shares issuable upon conversion of a Promissory Note. The discount enables the investor to convert into more shares than new investors are buying for the same cash, compensating for earlier risk taken.
A note that accrues interest and includes the option or requirement that it be converted into equity at the time of an equity financing, sometimes at a discount to the price of equity securities offered or subject to a cap on valuation.
A dividend that accrues for each share of preferred stock whether or not the company ever declares it. Because preferred stock is typically due its Liquidation Preference AND any unpaid dividends on a liquidation event, Cumulative Dividends effectively increase the Liquidation Preference over time, similar to interest on debt.
A standard right given to investors in priced-round investments that entitles investors to demand, subject to certain requirements, that the company register some shares for a public offering, facilitating the investor's ability to liquidate holdings.
Dilution is a reduction in the ownership percentage of a share of stock caused by the issuance of new stock. A share of stock is additionally diluted by the reservation of stock for or the awarding of securities convertible into stock. When the number of shares outstanding increases, each existing share represents a smaller ownership percentage in the company.
An atypical path to becoming a public company in which a company lists its existing shares directly on a stock exchange without conducting a traditional underwritten IPO and without raising new capital. In a direct listing, existing stockholders can sell their shares directly to the public on the listing date. Direct listings avoid IPO underwriting fees and lock-up periods but require the company to already have strong brand recognition and existing market demand.
A companion document to the definitive agreement in a financing or sale transaction containing exceptions to or disclosures called for by the representations and warranties provided by the target company.
A type of accelerated vesting triggered by two events: typically (1) a Change of Control and (2) an involuntary termination (without cause or constructive resignation) within a specified period after the Change of Control. Full acceleration under this version is generally acceptable to investors to a limited group of employees.
A contractual provision, often in Voting Agreements, that obligates parties to vote in favor of a sale of the company if a key group of constituents approves it, typically the board, a majority of common stock, and a majority of preferred stock.
An investor's or buyer's investigation into the obligations and potential liabilities of a target company in a financing or sale transaction. Due diligence is typically conducted with the assistance of counsel, accountants and other third-party advisors.
A document containing specific fact and document requests provided by an investor or buyer in a financing or sale transaction to the target company to facilitate such investor's or buyer's due diligence.
The agreement and plan governing the issuance of stock options to the company's service providers (employees, consultants, advisors, etc.). This is different tnan an employee stock ownership plan.
A program typically maintained by public companies that allows employees to purchase company stock at a discount to fair market value on a tax-advantaged basis, typically through automatic payroll deductions over an offering period.
The cost a grantee must pay to "exercise", or purchase, a share of stock subject to an option. For tax reasons, the exercise price is usually set at no lower than the fair market value of a share of the company's common stock on the date of grant.
Fair Market Value is the price at which property would change hands between a willing buyer and a willing seller, negotiating at arm's-length, with neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.
A special form of founder stock that is not common stock but preferred stock convertible into either common stock or the preferred stock issued in a later financing round. It can help facilitate a founder selling a portion of equity to investors at the same valuation as the financing round.
The most aggressive form of price-based anti-dilution (in favor of investors). It adjusts the conversion ratio of existing preferred stock so that such stock retains the same percentage on an as-converted basis as it did before the issuance of new shares at a lower price.
'Fully diluted' shares are the total common shares of a company counting not only shares that are currently issued and outstanding, but also shares that could be claimed through the conversion of convertible preferred stock or through the exercise of outstanding options and warrants.
Similar to a Partially Participating Liquidation Preference, except there is no cap on the preferred stock's participation in the proceeds with common stock after payment of the original investment amounts plus dividends.
Good reason' is a set of conditions that gives the employee 'good reason' to leave the company. Examples include a material reduction in compensation or responsibilities. Where an employee is entitled to severance, including vesting acceleration of equity awards, a resignation by the employee for 'good reason' is often a trigger for such severance.
A grant is the issuance by a company of an equity award, such as a stock option or restricted stock unit, by formal action of the company's board of directors.
A type of stock option that is eligible for favorable tax treatment if the requirements in the tax code are satisfied. An ISO may only be granted to an employee and to realize the maximum tax benefits the grantee must exercise the option and hold the shares until the later of two years from the date of grant and one year from the date of exercise. The issuing company is not allowed to take a corporate income tax deduction on the exercise of an ISO.
The first sale of a company's stock to the public, after the company has registered its shares with the SEC.
The body of federal tax law enacted by Congress. Regulations issued by the Treasury Department as well as myriad other guidance and publications by the IRS make up the comprehensive body of federal tax law in the United States.
An agreement typically put in place with the company's first seed or Series A round that sets forth certain customary rights of investors, such as Pre-emptive Rights, Registration Rights, rights to obtain financial statements and other information rights.
Life insurance on one or more 'key persons' to a company's future success (usually a founder, CEO, or lead technical employee). Sometimes required by investors as a condition to an investment. The proceeds are typically payable to the company.
The amount of money the holders of preferred stock are entitled to receive in a liquidation event (e.g., sale of the company) prior to the holders of common stock receiving any proceeds from that event.
A provision requiring the holder of company securities to abstain from re-selling those securities for a certain period after a company's public offering (typically 180 days for an IPO). The purpose is to facilitate price stability.
A customary rights letter given by the company to institutional investors in financing rounds that assists such investors in qualifying as venture capital operating companies (VCOCs), exempting them from certain ERISA regulations.
The group of employees principally responsible for carrying out the operations of the company.
Provisions in the company's Certificate of Incorporation that dictate when preferred stock is automatically converted into common stock. The two most common triggers are (i) a public offering meeting a minimum offering size or (ii) the vote or written consent of a specific percentage of the preferred stock.
The date on or after which repayment of a Promissory Note is due.
A provision in term sheets that prohibits the company from shopping the deal around to other investors. Also referred to as an 'exclusivity' provision. The No Shop typically ranges from 30 to 45 days.
An agreement not to engage in competitive business activities. For an individual, this typically means an agreement with their employer not to work for a competitor after leaving. Generally unenforceable in California outside the context of a company sale.
Dividends payable on stock that are only paid if and when they are declared by the Board of Directors of the company.
Entitles preferred stockholders to receive back their original investment plus any dividends owed in a liquidation event. The remaining proceeds go to common stockholders. However, an investor can elect to convert to common stock if they would receive more value as a common stockholder.
A stock option that does not meet the requirements for favorable tax treatment under the Internal Revenue Code afforded to incentive stock options (ISOs). NSOs can be granted to employees, directors, contractors, and advisors (unlike ISOs, which are limited to employees). Upon exercise of an NSO, the holder recognizes ordinary income equal to the spread between the exercise price and the fair market value, if any, subject to any applicable income tax withholding and payroll taxes.
An agreement not to solicit employees or consultants of a company to leave their current positions. A standard term in employment agreements.
The separate agreement that governs the sale of Promissory Notes in exchange for cash. Contains mechanics about how the sale will occur, representations and warranties made by both parties, and if, how and when the note is convertible into equity of the Company.
A written offer of employment setting out the key terms of the employment relationship, position, start date, compensation, equity, benefits, and at-will status. For startups issuing equity, the offer letter typically describes the equity grant (number of options or shares, vesting schedule) and specifies that the grant is subject to board approval.
A contractual right to purchase a specified number of shares of common stock at a specified exercise price. Options typically vest over time based on continued services by the grantee to the issuing company and must be exercised before expiration (typically 10 years from grant, or 90 days after termination of service). Generally options awarded to service providers are compensatory and have accounting, payroll and tax implications for the issuing company.
The agreement governing an option awarded to a service provider.
The issuance by a company of an option award by formal action of the company's board of directors.
A reserve of a company's shares set aside for purposes of making equity awards to service providers, including option awards.
The price per share an investor originally paid for the stock.
Like a Non-Participating Liquidation Preference, this entitles preferred stockholders to receive back their original investment plus dividends. In addition, remaining proceeds are shared pro rata between preferred and common (on an as-converted basis), up to a cap usually expressed as a multiple of the original amount invested.
A provision requiring certain stockholders to participate in a future financing or risk having their preferred shares converted to common stock or face other punitive actions such as loss of board seats or preemptive rights. Often used in 'down round' financings.
Vesting conditions that are satisfied upon something other than continued services. Typical performance vesting criteria include financial metrics, sales metrics, and product development milestones.
A right typically given to investors alongside Demand Registration and S-3 Registration Rights that entitles investors to have their shares included with any shares the company itself wants to register for public sale.
The valuation of the Company after the investors have made their investment. Typically, this is just the Pre-Money Valuation plus the total amount of investment in the round.
Also referred to as 'participation rights,' these are rights that entitle investors to invest in future financings in an amount equal to their current ownership percentage, with a 'gobble-up provision' allowing fully-participating investors to take up the allocation of investors who pass.
The dollar valuation the investors have placed on the Company prior to making their investment. Used to calculate the price per share for the preferred stock to be sold by the Company in a financing.
A class of equity with rights and preferences not held by common stock, typically issued to investors in venture financings. Preferred stock carries a liquidation preference (the right to receive a specified return before common stockholders in a sale), anti-dilution protection, conversion rights into common stock, and usually special voting rights including protective provisions.
An equity award that grants the holder an interest in the appreciation of a non-corporate company (e.g., an LLC) after the date of grant.
A written, dated and signed promise by the company to pay a defined sum of money to the holder of the note upon demand or at some specific future date.
The agreement employees of a company sign agreeing to confidentiality obligations and to assign the intellectual property created by that employee to the Company. This can also be referred to as a Confidential Information and Inventions Assignment Agreement.
The list of actions a company cannot take without the prior approval of a specified portion of the holders of preferred stock. Typically included in the company's Certificate of Incorporation.
A term used in convertible Promissory Notes that is often the trigger for the automatic conversion of the outstanding note amount into equity. Typically specifies a minimum round size.
Stock that is eligible for preferential tax treatment if the issuing corporation is considered a Qualified Small Business under U.S. tax laws. QSBS can provide significant tax benefits for founders and other stockholders of early-stage startups.
A right of preferred stockholders (typically in the Certificate of Incorporation) to demand that the company repurchase their preferred shares at the Original Purchase Price (or some other negotiated amount) after a certain amount of time has elapsed.
Rights of investors to cause the company to register shares of the investors' stock for sale to the public. The most common three forms are Demand Registration Rights, S-3 Registration Rights, and Piggy-Back Registration Rights.
Shares of a company that are subject to vesting conditions, typically awarded to a service provided in exchange for cash payment for the shares but sometimes awarded in exchange for services. A holder of restricted stock is a stockholder of the company (so can vote and receive dividends) but cannot transfer the shares.
The agreement governing the transfer of restricted stock to a service provider in exchange for cash payment.
An equity award that grants the holder a right to receive shares (or the equivalent cash value) at a future date following vesting and settlement. A holder of restricted stock units is not a stockholder of the issuing company but may become one in the future. Typically only granted by later stage private companies and public companies.
Entitles the holder of the right to be the first to 'refuse' a deal that the person subject to the right receives for the purchase of stock. From a founder perspective, this is the right of the company (and investors) to buy the founder's shares if the founder tries to sell them to a third party.
An agreement that dictates that founder shares are subject to a Right of First Refusal held first by the company, then secondarily by investors. If shares are not purchased through the ROFR, remaining shares are subject to Co-Sale rights, meaning an investor can tag along in any sale of the founder's stock by including a pro rata portion of their own shares.
The primary exemption from the registration requirements of federal securities laws applicable to equity awards granted to service providers. Once a company's equity issuances under Rule 701 exceed $10 million in a 12-month period, enhanced financial disclosure must be provided to recipients.
Similar to Demand Registration Rights, this entitles an investor (once the company is already a public company) to require the company to register some of the investor's shares for sale using the streamlined Form S-3 Registration process.
A type of Promissory Note where the borrower's promise to pay is backed by the lender having recourse to some collateral if the borrower defaults. The security/collateral is generally the assets of the company.
A type of accelerated vesting that causes all or a portion of shares to be deemed vested upon the occurrence of a single event, typically (1) a Change of Control and/or (2) an involuntary termination. Not too common.
The agreement and plan governing the issuance of stock options to the company's service providers (employees, consultants, advisors, etc.). This is different than an employee stock ownership plan.
An agreement pursuant to which someone purchases shares of stock from the company. If between the company and a founder/employee, includes vesting terms, acceleration provisions, the company's Right of First Refusal, and a Lock-Up Provision. If between the company and investors, it is the agreement pursuant to which investors pay cash in exchange for equity.
The agreement a founder signs to transfer intellectual property related to the company's business created by the founder prior to incorporating the company and signing a Confidential Information and Inventions Assignment Agreement or Proprietary Information and Inventions Agreement.
A type of Promissory Note where the borrower's promise to pay is not backed by any other property, and the only recourse the lender has if the borrower defaults is to take legal action.
A valuation figure used in Promissory Notes dealing with the conversion of the note into equity. The Valuation Cap is the maximum Pre-Money Valuation that could be used to calculate the price per share for conversion purposes, providing the investor with a more stable expectation of the percentage of the company they will own following conversion.
Vesting ties equity ownership (in the form of restricted stock) to time served with the company. The most common vesting terms for employees: 25% vests after 1 year (the 'cliff'), with the remainder vesting monthly over the next 3 years. A 'Right of Repurchase' is the mechanism by which the company retains the right to buy back unvested shares at the purchase price if service terminates.
The date from which a vesting schedule begins to run, often the employee's hire date for new hire awards.
The period of time over which an equity award vests pursuant to its vesting schedule (i.e., is earned). This is typically four years for employees.
A detailed timeline of the dates on which an equity award subject to service-based vesting conditions will meet such conditions and the corresponding number of shares subject to the award that will vest on such dates. For awards subject to performance-based vesting conditions, the vesting schedule details the performance criteria that must be satisfied and the corresponding number of shares subject to the award that will vest when such criteria are satisfied.
An agreement (typically put in place with the company's first significant third-party investment) that governs how, and by whom, the members of the company's Board of Directors are elected. Also typically the agreement that includes Drag Along Provisions.
In some financing deals involving convertible Promissory Notes, investors ask for warrants exercisable for shares of a series of the company's preferred stock. The number of shares the warrant is exercisable for is usually expressed as a percentage of the investment (principal amount of the Promissory Note) divided by the exercise price.