The venture world has its own language. You need to speak the lingo if you want to talk to investors.

At a recent pitch session, a founder had a beautiful deck and a well-rehearsed presentation. But when he reached the deal terms at the end, he said, “I’m offering 10% of the company for $1 million.”

Nobody groaned or laughed aloud, but you could feel the excitement exiting the room. We weren’t surprised when in the Q&A, the founder didn’t understand whether he was offering common or preferred shares and confused a provisional patent application with an issued patent. An immediate pass.

Offering X% of a company for $Y is easy to understand. It’s how to talk on Shark Tank. The public gets it. But it’s not specific enough for real investors. An experienced founder would instead say, “Raising $1M on a $10M post SAFE.” That won’t mean much to Shark Tank viewers, but tells a VC or angel investor exactly what we need to know.

I’ve seen many startups rejected because the founder, an engineer rather than an MBA, couldn’t answer how the revenue was being accrued, saying he had to check with the CFO. The company might’ve had a great product with enormous potential, but the founder/CEO didn’t know how to talk to investors. Should we care? That’s debatable, but we do.

Since we’re ultimately going to reject 98 out of the 100 startups that apply, we’re quick to reject any founder who doesn’t know the lingo as too inexperienced to consider.

Our assumption, be it right or wrong, is that if you don’t understand venture terminology, then even if you know how to build a product, you don’t know how to build a venture business.

Like every other industry, the venture world has its own language with specialized vocabulary. If you want to get investment, you have to speak with investors on their own terms, using their own terminology. So before you begin pitching, be sure to understand all the following words and concepts.

Deal Terms

The investment can take take different forms. Some investors prefer SAFEs or convertible notes, so be sure to understand the difference and be prepared to explain what you’re offering and why.

  • Equity: shares in the business. The equity can either be common shares, which is what the founders, employees, and advisors get, or preferred shares with special terms, which is what investors want.
  • SAFE: the Y-Combinator-developed template that acts as a shortcut to accept investment now and issue the actual equity later. It is called a “SAFE” or “SAFE agreement”, never ever a “SAFE note” since “note” means loan, and the SAFE was created specifically to avoid being considered a loan. The SAFE can be a post-money SAFE, a pre-money SAFE, may have a valuation cap with a discount, may be uncapped with a discount only, and may have an MFN.
  • Convertible Note (often shortened to just “Note”): a loan document used as a shortcut to accept investment now and issue actual equity later. The convertible note typically includes a pre-money valuation cap, a discount, an interest rate, and a maturity date.

Specific deal terms:

  • Valuation cap (usually just “cap”): The SAFE and Convertible Note, rather than including a valuation, usually have a valuation cap. There’s no significant difference with a valuation except investors get the lower of the valuation cap or the actual valuation at the time the equity is issued. A deal that does not include a valuation cap, relying a discount or MFN instead, is called an “uncapped SAFE” or “uncapped Note.”
  • Pre-money valuation cap or Post-money valuation cap (usually just “post” or “pre”): Pre-money valuation + investment added = post-money valuation. If I invest $1M at a $10M pre, the post is $11M. Sounds like basic arithmetic. The complication is that the investment includes all SAFEs and notes that will convert in the round, both previously issued SAFEs and notes and any that are issued in the future. Investors prefer the post-money cap because the valuation is fixed, whereas with a pre-money cap, the price we end up paying depends on how much money the company continues to raise prior to conversion.
  • Discount: The SAFE or convertible note investment is converted to equity at a discount to the price at time of issue. All convertible notes have a discount. Some SAFEs have a discount in addition to or instead of a valuation cap.
  • Maturity: Because the convertible note is legally a loan, it has a maturity date. This is the deadline to raise a priced round that triggers conversion or the loan has to be repaid.
  • Priced round: An investment round where equity is issued instead of a SAFE or convertible note. The valuation and number of shares outstanding determines the price per share.
  • MFN (Most favored nation): If another investor negotiates a better deal after I’ve already invested, if the SAFE or Note includes a MFN, then I get those better terms, too.
  • Side letter: The SAFE or Note is a standard agreement used by all investors in the round. Some investors may require special terms. Rather than making changes to the SAFE or note, those terms are put in a simple separate agreement of 1 or 2 pages.
  • Liquidation preference: Investors usually require that if the company is sold, they get a minimum of their original investment back prior to common shareholders getting anything. Sometimes investors demand a guarantee of 2x their investment back, sometimes even 4x. Next to valuation, this minimum return is the most important deal term.

Corporate Structures

Investors want to invest in C-corps and avoid LLCs. So you’d better know the difference:

  • LLC (Limited Liability Company): a simple corporate structure that provides liability protection and an equity-like structure (called “units” instead of shares) but is not taxed directly. All profits and losses of the business flow through to the owners’ personal taxes.
  • S-Corp: Similar to an LLC — a small business corporation where profits and losses flow through to the owners without the corporation being taxed directly. S-corps have limits on who can hold shares and the total number of owners.
  • C-Corp: The standard corporate structure with no limits on shareholders. C-corps have to pay corporate income taxes on their profits (rare for a startup) are taxed. However, investments in C-corps are eligible for highly attractive QSBS tax incentives.
  • QSBS (Qualified Small Business Stock): a C-corp with an operating business and less than $50M in assets at the time of investment. In other words, an early-stage startup. QSBS investments are eligible for very attractive tax incentives.
  • LLC conversion: the process of converting an LLC to a C-corp. If the business is an LLC, investors will require a LLC conversion.

Legal and Patents

Investors will ask lots of questions about the company’s legal situation and the intellectual property rights. These are fundamental to the company’s viability, so founders need to be able to answer these questions without calling the lawyer.

  • Proprietary rights agreement: All intellectual property rights related to the company and its products have to be assigned to the company. Otherwise, if the founder or employee leaves, there can be questions about who owns those rights. Investors will check that all founders, employees, and consultants have signed a proprietary rights agreement. You’d better know the difference between this agreement and a non-disclosure agreement (NDA).
  • Intellectual property: all rights the company owns including patents, copyrights, trademarks, and trade secrets. Be prepared to discuss which type of protection you’re using against competition and why.
  • Patents: an exclusive right issued by the government to use an invention for a fixed period of time. Make sure to know the difference between utility, design, and plant patents. Be prepared to discuss which patents have been issued in which countries and what they cover, as well as provisional and full patent applications. Know whether your patent applications are domestic or international PCT applications, and be ready to discuss which countries you’re applying for patent protection and why.
  • Freedom to Operate: This is a report by a patent law firm that checks whether any competitors have patents you might be infringing.

Accounting

Accounting is the language of business. If you don’t understand your financial numbers, you’re destined to fail. Investors need to understand the status and prospects of your business. If you don’t understanding accounting, take a class before going any further because you won’t go far without it.

Critical terms you need to understand are:

  • Accrual: just because someone ordered your product doesn’t mean it counts as income. Income is only counted when you deliver the product. And if it’s a subscription, like SaaS products, that income has to be divided up over the subscription period. Investors expect you to be precise about your most important metric.
  • Burn rate/Runway: How much money are you losing each month? That’s your burn rate. Divide that into how much cash you have and that’s your runway — how many months before you run out of cash. These are critical numbers for investors to understand how far their investment will go before you need to raise the next round.
  • CapEx/OpEx: If you’re building a factory to make batteries, you’ll have hundreds of millions in upfront costs for the land, building, and equipment. Those are capital expenses, and have to be added to the product cost by amortizing over their expected lifetime. Without factoring in the capital costs, there’s no way to understand pricing and profit margins.
  • Dilutive/non-dilutive funding: When you sell stock in the business, it dilutes the percentage ownership of the existing shareholders. That’s dilutive funding. Investors love to see non-dilutive funding such as government grants that don’t dilute their holdings.
  • Customer metrics: As you start building revenues, investors will want to dive into the numbers. Be prepared to answer questions on the CAC (customer acquisition cost), ARPU (average revenue per user), CLV (customer lifetime value), churn rate, and CRR (customer retention rate).

Summary

If you’re new to the world of startups, and especially if you’re a technical founder unfamiliar with the language of business, there’s a lot to learn. Some of it is just knowing the terminology, while some of it is understanding how to run a business. Fortunately, none of it is particularly difficult to pick up with a bit of work. Once you’re up to speed, you’ll be able to talk with investors like the pro you need to be.

I’m sure I’ve missed plenty of terms you heard from investors that you found baffling at first. Please add them to the comments for the benefit of all the other founders.

Before Dr. Katie Deauville went to pitch her teleportation startup, SüprDüpr, to BiteCoin Ventures and Sam Hill Capital Partners, she studied how the venture partners talked. She was helped by Satoshi Nakamoto, the king of crypto and managing director of BiteCoin Ventures, who she invited to join the company’s board. That helped her raise billions in funding for the most valuable startup ever. But does the product actually work? If so, why is one of the scientists missing? His friend, the hacker, Ted Hara, is on a mission to find out. Read more in my farcical, award-winning Silicon Valley mystery novel, To Kill a Unicorn.