M&A Glossary

4 Years with a 1-Year Cliff is the typical vesting schedule used by startups. A one year cliff means that nothing vests for the first year, but after a year the vesting would catch-up to 12/48, and then the remaining balance would vest over three years (typically 1/36 a month for 36 months).

Section 409A of the Internal Revenue Code regulates the treatment of non-qualified deferred compensation to service providers for federal income tax purposes. A company must issue stock options at fair market value in order to legitimately benefit from this section of the code and will typically hire a third-party agency to issue a report determining exactly what that is. The report is commonly known as a 409A valuation and they are critical to issuing stock options for a venture backed company. Most startups order at least one per year, or after a material financing event, whichever is sooner.

An 83(b) Election is an election made under the Internal Revenue Code that allows a person receiving shares (or units) under a vesting schedule to recognize income based on the entire value of the shares as of the date of the grant – instead of as the shares vest. Basically, you accelerate the ordinary income taxes. In the context of a startup, the ordinary income liability at the time of the grant is negligible because the value of shares early on is so nominal. You want this. But if you fail to file an 83(b) election, then you will be liable for paying ordinary income taxes on the difference between fair market value and the grant price when the shares vest. If your company’s value is increasing over time, this could be a nasty consequence.

Accelerated Vesting is a process whereby a holder of restricted equity has the vesting schedule sped-up, or accelerated, upon the occurrence of a certain event or events, i.e. termination of the holder without cause or a sale of the company.

An Acceleration Clause refers to a contractual clause which allows debt owed over time to be “accelerated” so that it is owed immediately. You see this most often in promissory notes, where a default or breach of a provision of the agreement will cause the entire debt obligation to accelerate and become due immediately.

Accredited Investor is defined under the Securities Act of 1933. Anyone (individual or entity) who meets the definition is able to invest in certain private offerings. Simply put, an accredited investor is an individual with a net worth (individually or with a spouse) of at least $1,000,000 exclusive of a primary residence, or who has earned at least $200,000 individually, or $300,000 jointly with a spouse in each of the last two years. There is also a long list of ways that an entity can qualify as an accredited investors.

Actual knowledge is the knowledge that an individual person has in his/her brain. If an entity is involved, Actual Knowledge means the knowledge in the brains of the officers, directors, or other persons designated in the agreement as relevant for purposes of determining the knowledge of a company. Actual Knowledge does not require the individual person or entity to conduct any investigation, due diligence, or other actions.

An Advisory Board is less formal than a startup’s board of directors. An advisory board typically consists of people whose experience, knowledge, and influence can benefit the growth and direction of the startup.

An Allocation Schedule is a schedule or attachment, typically to an Asset Purchase Agreement, that separates the purchase price among the assets being purchased in accordance with their general value. The Allocation Schedule is broken up into seven categories of assets and the non-compete, matching the Form 8594 that each party will file with their tax returns reflecting the transaction.

Annual Recurring Revenue (ARR) is the amount of revenue a company generates from recurring payments over a year.

Articles of Incorporation (AOI) are what some states, including California, call the primary organization document for a corporation. In Texas, it’s called a “Certificate of Formation” and in Delaware it’s called a “Certificate of Incorporation.” Many people just refer to these docs as a corporation’s charter.

As-Converted Basis refers to the calculation of securities assuming conversion of all stock.

An Asset Acquisition is a transaction whereby an acquirer purchases the assets of the company, rather than the ownership interests.

The main definitive agreement when an acquisition will be a sale of assets of the target company.

Assets are physical property, intellectual property, inventory, and other property (whether physical or intangible) of a company.

An Assignee is the person receiving the assignment of the contract or asset.

An Assignment and Assumption Agreement is an agreement between two parties, the assignor and assignee where the assignor is assigning his/her/its rights under an agreement or obligation to a third-party, the assignee, and the assignee is assuming the obligations under the agreement or obligation.

An Assignor is a person (whether individual or entity) assigning a contract or asset to another person

An At-Will Employee is an employee whose employment with the Company can be terminated by the company or the employee for any reason.

A Balance Sheet is one of the four main financial statements that provides a summary of a company’s finances at a specific point in time. All balance sheets include a company’s assets, liabilities, and equity. Unlike other financial statements, the balance sheet provides an accurate summary only at the time it is created.

A Bill of Sale an agreement used to transfer physical assets such as equipment, inventory, office supplies, or similar.

Blue Sky Laws are securities restrictions enacted at the state level, established to protect a state’s investors. These regulations prohibit brokers and investment advisors from recommending, soliciting, or discussing any security with a client unless that security is compliant with the Blue Sky laws of the state that the investor resides in. With startups, the more states they plan to raise money in, the more sets of Blue Sky laws they will have to comply with.

Board Consent is the consent to some company action by the board of directors for actions or transactions that need director approval. Board consent can be effected at a meeting or in writing.

A Board of Directors is a group of people from outside or inside the company who are elected by shareholders to make long-term, strategic, and broad company policy decisions. Boards can be almost any size, but the most effective boards in startups are often 3-5 people.

Boilerplate is a standard provision that appears in every legal document and effectively means the same thing in every document. The provision may be worded differently, but the provision achieves the same result.

Book Value is the total assets minus the total liabilities of a company. The book value of an asset, as shown on a balance sheet, is typically based on its original cost minus accumulated depreciation. The book value is used for both accounting and tax purposes.

A Break-up Fee is a penalty paid by a potential acquirer to a startup if the potential acquirer backs out of an acquisition. In rare instances, this can also apply in financing rounds.

A Bring Down Certificate is a signed certificate certifying the company’s Representation and Warranties are still true as of the date of the certificate. Bring Down Certificates are often used to certify that the representations and warranties made in an agreement are still true at a later closing date.

A Broker-Dealer is an individual or firm that buys and sells securities or acts as an intermediary for such sales.

Burn Rate is calculated as monthly revenues less expenses. It is typically negative because expenses are so high for a startup relative to revenues. Burn rates are helpful in measuring how quickly a startup will go through all of its cash.

A Business Plan is a long document developed by a startup which lays out the blueprint for the startup – including the revenue model, growth plans, market information, and other relevant data. Business plans are not typically requested by investors, but the process of creating one can be useful.

A Buy-Sell Agreement is an agreement between co-owners that governs the purchase of one party’s entire ownership share in a business. A buy-sell is typically used in a 50/50 ownership situation as a mechanism to avoid the dreaded deadlock.

A Buyout is a takeover action by an outside investor. The investor purchases a controlling interest in the company, “buying out” the current ownership.

The Bylaws of a corporation set forth the rules for governing corporate matters.

A C-Corporation is a legal entity that allows for limited liability. C-Corporations are legally considered separate entities from their owners. Income is taxed at the corporate level and is taxed again when it is distributed to owners, potentially resulting in double taxation. Despite the double taxation, C-Corporations are the preferred entity for a startup because of familiarity and their ability to scale. That said, a C-Corporation is not right for everyone. Consult with your legal and tax advisors regarding the best structure for your startup.

A Capital Account is a ledger in an LLC which tracks the contributions and distributions to members. Each member’s capital account is oftentimes adjusted by allocations and distributions of the company’s profits and losses.

Capital Gains is the profit from the sale of an asset or property. Taxes on capital gains are typically much lower than taxes on ordinary income.

Capital Stock is the shares of stock of a corporation, usually in multiple different classes.

A Capitalization Table or Cap Table is a record of the owners of a company and their ownership percentage of the securities issued by the company. It is typically presented in a spreadsheet.

A Carveout is an exception from a stated provision in a contract.

A Certificate of Formation is a legal document that is filed in Texas with the secretary of state to create a corporation, limited liability company, and similar entities. Certificates of formation will contain the entity’s basic information (name, registered agent, office address, share structure, etc.). This is known as a Certificate of Incorporation in Delaware.

A Certificate of Incorporation is a state filing that creates a corporation once filed with the secretary of state. The filing informs the secretary of state about the name the company plans to operate under, whom the state can serve process on (the registered agent), where to mail important documents, and equity classification information.

A Change in Control (or Change of Control) transaction is one whereby the owners of a company prior to a transaction no longer own a majority of the shares after the transaction.

The Chief Executive Officer (CEO) is typically the head-honcho of the company. In the context of a startup, “president” and “CEO” are usually synonymous.

Churn Rate is the loss of future revenue due to the loss of a customer/subscription. There are two types of churn: Gross Churn and Net Revenue Churn.

Gross Churn: MRR lost in a given month/MRR at the beginning of the month
Net Churn: (MRR lost minus MRR from upsells) in a given month/MRR at the beginning of the month

A Cliff is a term used to describe the length of time it takes for stock options or other securities on a vesting schedule to partially or fully vest.

Example:

A typical vesting schedule for a startup is monthly over 4 years, with a one-year cliff. This means that the recipient of the equity will receive nothing for the first year, then 25% after the first year, and then the remaining 75% will vest monthly over 36 months.

A Closing is the date, sometimes specific time, and process by which a transaction will be completed.

The Closing Date is the official closing date of a transaction. Typically the date when the first payment is made by the Buyer/Purchaser, and most (or all) of the assets or ownership of the Seller are transferred.

The Closing Documents are documents such as assignments, bills of sale, Treasury certificates, officer certificates, closing statement, funds flow statement, bring down certificates, and similar documentation signed at closing by the parties. These documents assist in transferring assets, confirming closing funding of the purchase price, and other key closing tasks.

Collateral is a debtor’s asset that the debtor allows a creditor to have rights to until the debtor’s obligations are satisfied. A company can grant collateral in any of its assets, but most often collateral is granted in inventory or equipment.

Common Stock is an equity ownership in a company. Common stock is typically issued before any other type of equity. Once a company has raised capital, common stock typically has junior liquidation and distribution rights to other stockholders and creditors.

A Company Agreement is an internal document for an LLC that provides the framework for how a limited liability company operates. According to the TBOC, “It governs the relations among members, managers, and officers of the company, assignees of membership interests in the company, and the company itself; and other internal affairs of the company.”

A Company Record Book is also called a “Corporate Record Book”. Simply, it is a book that houses your important company documents. In the old days, companies kept a three-ring binder with this important information. Today, it’s common to house this information electronically. It’s imperative to keep your corporate records in one place to share with your legal and tax advisors, as well as with investors from time to time.

Consideration is the benefit that both parties get in a contract. In order for a contract to be binding, there must be consideration on both sides. Consideration can be something you will do, or something you will not do.

Constructive knowledge is knowledge that an individual should have know by virtue of his/her/its position in a Company and/or after due inquiry of others in the Company. Constructive knowledge is a definition of knowledge frequently used in an Asset Purchase Agreement or Stock Purchase Agreement in relation to the Seller.

Controlling Interest generally means voting rights held by 1 person that constitute more than the necessary votes to pass most actions in a Company. Usually a Controlling Interest means more than 50% of the voting interests in a Company (at least a simple majority).

A Convertible Note is short-term debt that converts into equity, typically in conjunction with a financing round. By using a convertible note, the investor would be loaning money to a startup, and instead of a return in the form of principal with interest, the investor would receive equity in the startup.

Corporate Governance is the manner in which an entity is governed and regulated. The term is used across all entity types – corporations, LLCs, and partnerships. Corporate governance documents include the certificate of formation/incorporation and bylaws for a corporation, and the certificate of formation and company agreement (or operating agreement) for an LLC.

A Corporate Resolution is a document that sets forth the actions of a corporation’s board or shareholders. In the context of an LLC, it may simply be called a “resolution.” A certain level of consent is required for a resolution to be approved.

A Data Room is an online repository of company docs. Typically, a startup will create a data room of relevant company documents to share with potential investors. This is preferred to emailing out docs because the startup can keep them all in one place and update them as necessary. The company can also password protect the data room in order to limit access.

The Date of Issue is the date that the securities (shares or units) are issued to an investor.

Deadlock is a situation, typically involving opposing parties, in which no progress can be made on a decision or issue. For a Company, deadlock may arise where a decision must be made by the managers/Board of Directors OR the members/shareholders and no group has sufficient votes to pass or reject a particular decision. Many times arises when there are an even number of Managers/Directors or two Members with 50-50 voting power and no dispute resolution mechanisms exist.

Default is when a company is unable to perform the obligations it agreed to in a loan agreement. Which failures by the company constitute default and which rights creditors have upon default vary from agreement to agreement. Often, default is failure to make payments on a loan.

DGCL is Delaware General Corporation Law. These statutes govern corporate law (including LLCs) in Delaware.

A Director is an elected or appointed person who sits on the board of directors and helps the corporation to make certain decisions. Typically the board of directors is responsible for setting the strategic direction of a company.

Directors and Officers’ (D&O) Insurance is insurance purchased by a company to protect its directors and officers from claims arising out of company activities or to indemnify them for such claims.

The Disclosure Schedules are a collection of fact-specific disclosures such as lists of assets, and exceptions to specific statements related to the seller’s representations and warranties in a purchase agreement. Disclosure Schedules may be used for a variety of purchase agreements, including purchases of assets, stock, mergers, investments in companies, real estate sales, or other transactions.

Distribution is a payment by a company to its shareholders (or members in the context of an LLC).

Divestiture means the process of selling off subsidiary business interests, investments, or assets, many times to a third party. A Divestiture may also be used to spin off or split certain assets into two or more separate businesses.

A Dividend is a payment made by a corporation to its stockholders. Dividends can be paid in cash or stock. Startups rarely, if ever, pay dividends.

A Division of a company is a department, area group, or other portion of the company that sells particular products and services, or supports a particular industry. A Division of a Company, rather than the entire company, may be sold during an acquisition transaction.

A Double Materiality Scrape is a clause in a purchase agreement that states that when determining (a) whether any given representation or warranty in a purchase agreement is accurate or inaccurate (a breach of the representation or warranty), or (b) the amount of losses resulting from a breach of the representation or warranty, any “materiality” or Material Adverse Effect (“MAE”) qualifiers in the representations and warranties will be disregarded (“scrapped”) for indemnification purposes.  A Double Materiality Scrape is very favorable to the Buyer in a purchase transaction.

Drag Along Rights are the rights of majority investors who are selling their equity in the company to force minor investors to sell their equity interest as well.

Due Diligence is the process an investor or buyer goes through prior to making an investment in a company. This typically includes meeting and interviewing the founders and key stakeholders, reviewing company documents and financials, and interviewing customers, when applicable.

Duty of care is the duty the directors/officers of a corporation owe to make decisions in the corporation’s interests with reasonable diligence and prudence. Duty of care is defined in corporate statute or caselaw in many states.

The Duty of Loyalty is the principle that directors and officers of a corporation, in making decisions in their capacities as officers and directors of the Corporation, must act without personal economic conflict. The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity.

Earnings Before Interest and Taxes (EBIT) is an operating profit metric. The EBIT is determined by excluding interest and taxes from expenses and then subtracting those expenses from revenues. Companies’ values are often projected as multiples of EBIT.

EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it.

An Earnout is a portion of a sale agreement whereby the sellers receive certain payments contingent on future events, typically revenue or profit milestones.

The Effective Date means the date on which a document and its contents will go into legal effect. The Effective Date may be different in certain circumstances than the date the document is signed.

An Employee is, in most states in the United States of America, an individual who works for a company where the company controls the manner, means, equipment, and timing of the performance of the work. Most employees receive payment for the services as W2 compensation.

An Employer Identification Number (EIN) is the number issued by the IRS to a company that identifies the company as a taxpayer in the US. An EIN is required for a company to open up a bank account and file taxes.

An Encumbrance is a claim made against a property by someone other than the current titleholder of the property. Examples of encumbrances include leases, liens, easements, mortgages, deeds of trust, or similar devices.

Equity broadly refers to the ownership of a company, which can be represented by stock or other units of ownership. When an investor has ownership of a company, he or she has equity in the company.

Equity Consideration is when the sellers in an acquisition transaction receive all or part of their purchase price payment in equity (stock, membership interests, partnership interests, or similar) of another company, which is usually the buyer or the buyer parent company.

An acquisition agreement where the sellers are selling their stock, membership interests/units, partnership interests, or similar, rather than the assets of the company. An Equity Purchase Agreement may also be called a Membership Interest Purchase Agreement or a Stock Purchase Agreement, or variants thereof.

Escrow describes documents, funds, and/or other assets being held by a third party until the parties of the transaction have satisfied certain obligations.

An Exclusivity Provision is a binding provision in a letter of intent or memorandum of understanding that one party (typically the seller) will not negotiate with or entertain offers to sell the assets or stock of the seller company from any other party other than the Buyer for a fixed period of time. This may be binding on both parties in the case of certain types of mergers.

The Exercise Price is the price per share at which an option is exercised, i.e. the price at which the option holder can buy or sell the underlying security.

Exercising Stock Options means the option holder purchases the underlying stock, at the exercise price, in accordance with the option agreement.

An Exit Event is an event where founders and early investors can sell their interest in a company for cash. An exit can be an initial public offering (IPO) or an acquisition by another company.

Expenses are the cost or costs required for something or the money spent on something. In a mergers and acquisitions transaction, a company may be asked to itemize “Transaction Expenses” that are paid at closing from the cash received by the sellers, owners, or other parties to the transaction.

An Expenses Provision is a section in a letter of intent or memorandum of understanding that sets out the liability of each party with respect to the expenses associated with due diligence and negotiating the transaction documents in the event that a transaction does not close. Typically the Buyer wishes for the Seller to pay a fixed portion of the expenses. The Expenses Provision may also provide that each party is responsible for its own expenses, costs, and fees associated with due diligence and negotiating the transaction documents.

A Finder is an individual who facilitates transactions, whether acquisitions or M&A, between companies and other parties.

A Finder’s Fee is a commission paid to a third-party for facilitating successful transactions, whether acquisitions or M&A, between a startup, investors, or potential partners.

An F-Reorganization is a type of tax free reorganization under Section 368(a)(1)(F) of the Internal Revenue Code. An F-Reorganization is a change of form, not substance of the entity.

Fair Market Value is the price that a reasonable third-party would pay for a given asset in the open market.

Fiduciary Duty is the legal and ethical duty that an individual has to an entity, which includes the duty of care and the duty of loyalty.

The Foreign Corrupt Practices Act (FCPA) makes it unlawful for U.S. companies and individuals to offer anything of value to foreign officials in order to build or retain business.

Formation Documents include the basic documents signed and completed during the formation of a company. This will always include the Certificate of Formation, Articles of Incorporation/Organization, or Certificate of Incorporation/Organization. The Formation Documents may include items such as (2) Resignation; (3) EIN/Tax ID’s; (4) Resolution, minutes, or consent for organizational matters; (5) Operating Agreement/Company Agreement OR Bylaws; and/or (6) other documents, such as Shareholder Agreements, Buy-Sell Agreements, or other documents.

A Founder creates or participates in the formation stage of a startup. Founders receive the startup’s initial shares in return for a capital contribution or services provided to the company.

Founders Stock refers to equity granted to a founder when the company is formed. The equity typically has a par value that is next to nothing and a four year vesting schedule.

Fully-Diluted Basis is the total number of shares that would be outstanding if all securities that could convert into shares, such as convertible notes, options, warrants, and preferred shares, converted to common stock. Investors oftentimes want to know what their ownership will look like on a basic and a fully-diluted basis.

A Fund Flow Statement is a financial statement prepared to analyse the reasons for changes in the financial position of a company between two balance sheets. It portrays the inflow and outflow of funds.

A General Partner (GP) is a partner in a partnership. In limited partnerships, there are general partners, who manage the day-to-day operations of the partnership, and limited partners, who invest in the partnership but are not allowed to control the day-to-day operations or they risk becoming a general partner. Unlike limited partners, general partners do not have limited liability. Thus, funds that use a limited partnership structure often have general partners that are LLCs or other limited liability entities.

A General Partnership is the default entity under most jurisdictions. When two or more entrepreneurs join together to operate a business, they have wittingly, or unwittingly, formed a general partnership. There is no need to file any document with the state to formalize or legitimize their undertaking. You want to avoid a general partnership.

General Solicitation is a company or fund publicly advertising its securities. General solicitations offer the potential to reach more investors. However, general solicitation may cause the company to have to comply with more stringent security registration requirements at the state and federal levels.

Generally Accepted Accounting Principles (GAAP) are mandatory financial accounting procedures and methods that public companies must comply with when reporting their financials. Private companies are not required to use GAAP as their accounting method, but many do.

Gross Profit is the profit a company makes after deducting the costs associated with making and selling products and/or providing services.

A Holdback is a portion of the purchase price that a purchaser does not immediately give to the seller upon closing in order to ensure that there are no post-closing issues with any of the representations and warrants of the seller. See Holdback Escrow.

A Holdback Escrow is a portion of the purchase price that a purchase does not immediately give to the seller upon closing to ensure that there are no post-closing issues with any of the representations and warranties of the seller. The purchaser places the holdback escrow in a third-party escrow account until the holdback period has elapsed and the representations and warranties made by the seller have not been deemed breached, and at which point the holdback escrow is released to the seller. The holdback escrow amount is usually a percentage of the total purchase price.

A Holding Company is an entity created for the purpose of owning entities and assets.

A Holding Period is the amount of time that a person or entity owns an asset or security.

The Hurdle Price is the price associated with an incentive unit in an LLC. Incentive unit holders are entitled to distributions only when each non-incentive unit holding member of the company receives distributions per unit in an amount equal to the hurdle price.

An Incentive Stock Option (ISO) is a type of stock option typically granted to founders or key executives. ISOs receive long-term capital gains treatment if the shares are held for more than a year from the date the shareholder receives the options, as opposed to when the options are exercised. Also, the shareholder is not taxed until the options are exercised, as opposed to when the options are received.

An Incentive Unit Plan is used by an LLC to incentivize and compensate service providers to the company, similar to a Stock Option Plan in a corporation. An incentive unit gives the recipient a right to the future profits of the company after the date of the grant (hence, incentive units are also known as “profits interest”).

An Income Statement is a financial statement that shows a company’s income and expenditures. It also reflects net profit/loss for a given period. An Income Statement is also called Profit and Loss Statement.

Incorporation is the act of incorporating a company through filing a required document with the secretary of state and paying an incorporation fee.

Indemnification is compensation for a harm the company may not have caused but had to pay for. Generally, a third party is harmed and a company must pay the third party for wrongful acts committed by another party. The party who caused the harm must compensate the company for the money the company paid to the third party.

An Indemnification Cap is the maximum amount that a company in a contract may have to pay to another party to the contract for the company breaching one or more representation and warranty provisions in the contract. These caps are typically present in a sale or purchase agreement.

Indemnity is a company’s agreement to pay another party’s losses under a contract regardless of whether the company caused the losses.

An Independent Contractor is a service provider under a contract, but unlike employees, the independent contractor controls how the service is performed. Whether the service provider controls the performance and is an independent contractor or whether the service provider does not have control over the performance is determined using a factored analysis in most states. Some of these factors are how the service is performed, when the service is performed, what tools are used to perform the service, who provides the tools, and what workers perform the service.

An Indication of Interest (IOI) is a preliminary letter sent by a buyer (sometimes an investor) to indicate a basic level of interest. It’s one step past “nice to meet you,” but well short of a Letter of Intent, and no where close to a binding document. See also Letter of Intent (LOI) or Memorandum of Understanding (MOU).

An Initial Public Offering (IPO) is the first sale of a company’s stock on a public stock exchange. The company must comply with stringent SEC requirements to be eligible to be a publicly traded company. And, in most instances, a startup has been very successful if it reaches an initial public offering.

Intellectual Property is intangible property such as a process, a design, a code, company secrets, or images that are protected by patent and copyright law.

Interest is a fee paid at a particular rate for borrowing money from a lender.

An Invention Assignment is an agreement where a founder or developer assigns to the company all of the intellectual property the founder or developer has created related to the company.

Inventory means physical assets maintained by a company for sale to customers/clients in the ordinary course of business.

An Investment Adviser is an individual or company who is paid for providing advice about securities to a client. The individual/company must be registered with the Securities and Exchange Commission. Investment Advisers may assist clients with setting up and managing brokerage accounts, investing in companies or companies looking for investors, and mergers and acquisitions transactions.

An Investor Rights Agreement (IRA) is an agreement between an investor and a company that contractually guarantees the investor certain rights including, but not limited to, voting rights, inspection rights, rights of first refusal, and observer rights.

An IPO is an initial public offering of a company.

The Issue Price is the price at which a company’s securities are sold.

Issued Shares are the amount of shares the company has sold or granted to shareholders.

An Issuer is an entity that has “issued” or sold its securities.

A Joinder references a document used to join a new party (such as a shareholder/member) to a document already executed by other parties. By way of example, a joinder may be used to add a new member to an Operating Agreement or Company Agreement.

A Joinder Page is a signature page executed and joined to an agreement that was previously executed. The person executing the joinder page becomes bound by the agreement.

A Joint Venture is an agreement between two or more parties where they agree to contribute assets, resources, or services toward a particular goal or project.

Jointly and severally is a term used in acquisition agreements where more than one party will be responsible for indemnification. Jointly and Severally refers to the fact that both parties are responsible for the entire item, rather than only their pro-rata share based on ownership of the company.

Junior Debt is debt that is a lower priority to senior debt. Junior debt is also known as “Subordinated Debt.”

A Key Employee is an employee who plays a significant part in a startup’s success and has a major ownership and/or decision-making role in the business. Key employees are usually founders and C-level executives. Key employees may have certain restrictions or be tied to certain provisions in a later-stage financing round.

A Lapsed Option is an option that can no longer be exercised because some necessary condition has expired. Often stock options are granted but have a finite time period within which the options must be exercised. Once the finite period ends, the options that have not been exercised are said to “lapse.”

An agreement to lease real property or personal property, typically for a fixed period of time.

A Letter of Intent (LOI) is a document that indicates the material points of a deal, or intent of the parties. It is typically non-binding and a precursor to more definitive documents; though it is not uncommon for certain provisions (like confidentiality, exclusive negotiation period, or break-up fees) to be binding. See also Indication of Interest (IOI)

Liabilities, in the mergers and acquisitions context, any and all debts, losses, damages, adverse claims, fines, penalties, liabilities or obligations of any kind, whether direct or indirect, absolute or contingent, accrued or unaccrued, matured or unmatured, determined or undeterminable, due or whether to become due or on- or off-balance sheet, and whether in contract, tort, strict liability or otherwise, including any arising under any law, action or order, and including all costs and expenses relating thereto (including all reasonable fees, disbursements and expenses of legal counsel, experts, engineers and consultants and costs of investigation). Liabilities are generally defined very expansively by a buyer in order to protect the buyer from taking on any obligations of the Seller/Target after completion of the transaction.

A License is an agreement between an intellectual property owner and an individual or entity for the use of the intellectual property. The individual or entity does not purchase the intellectual property, but just the right to use or benefit from the intellectual property for a certain period of time and only for certain uses.

An Limited Liability Company (LLC) is the best of both worlds when it comes to entities. An LLC offers the benefits of limited liability, taxations as a partnership, and management flexibility. An LLC can elect to be “manager-managed” or “member-managed.”

A Limited Liability Partnership (LLP) is a General Partnership with an important modification: the partners are not personally liable for all debts and obligations, except to the extent they have agreed bear personal fault.

Limited Partners (LPs) are partners in a limited partnership that are not personally liable for the company’s debts or liabilities. The limited partner invests in the company but cannot exercise control over the day-to-day operations of the company. If the limited partner does exercise such control, the limited partner may lose its limited liability protection.

A Limited Partnership (LP) has two classes of partners: General Partners and Limited Partners. General Partners in an LP are like General Partners in a conventional partnership (i.e., have personal liability for the debts of the business). Limited Partners are not liable for debts of the business.

A Liquidation Event is typically defined as a sale of substantially all of the assets of the company (not in a bankruptcy scenario). In investment agreements, liquidation events often trigger investors’ rights regarding distributions, conversions, or preferences.

Liquidation Preference specifies which investors get paid first and how much they get paid in the event of a liquidation event, such as the sale of a company. Liquidation preference helps protect investors by making sure they get their initial investment back before other parties. Preferred stockholders have preference over common stockholders.

A Lock-up Period is a mutually agreed upon period of time following an IPO that founders, key employees, and investors are restricted from selling their shares in the company.

Losses means claims, losses, liabilities, damages, deficiencies, Taxes, costs, interest, awards, judgments, penalties and expenses, including reasonable attorneys’ and consultants’ fees and expenses, and including any such expenses incurred in connection with investigating, defending against or settling any of the foregoing.

An M&A transaction is a merger or acquisition transaction whereby one party purchases the assets or stock of another, and/or two parties merge together into one entity.

Major Investors are investors who own a large portion of a company’s shares and as such receive preferential rights. The amount of shares necessary to become a major investor varies among financial documents and companies.

A Majority Shareholder is a shareholder who owns more shares in the company than any other shareholder.

Material Adverse Change Clause is a contractual provision that states the transaction will not take place if some event occurs. These provisions are found in venture financings.

Material Adverse Effect is a term of art used to denote materiality in a mergers and acquisitions transaction, specifically the negative effect that a particular event may have on a particular business or party. Often defined in the Purchase Agreement for the transaction.

Materiality Qualifier is modifying a part of a contract to require a higher threshold. For example, a “material” breach of a contract requires the bad actor to commit a greater wrong than just a breach of any term of the contract.

A Materiality Scrape is a provision generally found in purchase agreements (i.e. stock purchase agreement, asset purchase agreement, merger agreement, etc.) that effectively eliminates any materiality qualifiers in representations and warranties for determining whether a breach has occurred in regard to indemnification provisions.

A Membership Interest Purchase Agreement is an equity purchase agreement to purchase the Membership Interests or Membership Units of an LLC.

A Memorandum of Understanding is similar to a Letter of Intent and may be used by the parties to indicate the material points of a deal in a non-binding manner prior to executing and negotiating definitive agreements.

Mergers and Acquisition (M&A) is a term used to refer to the corporate strategy involved in the consolidation of companies.

Monthly Recurring Revenue (MRR) is the amount of revenue a company generates from recurring payments in a single month.

Newco is a name given to a hypothetical company for ease of description before the company actually has a name. Well, other than the few companies actually named Newco. Yes. They exist. We checked.

A Non-Compete is an agreement signed by employees and management prohibiting the individual from working for or forming a competing company. Non-competes include a specified geographic region and last for a specified time period after termination.

A Non-Disclosure Agreement (NDA), also known as a confidentiality agreement, is a contract in which a party agrees to protect confidential information from disclosure to other parties. Be leery of asking investors to sign NDAs; they see too many deals and chances are that your startup is not unique.

A Non-Qualified Stock Option (NQSO or NSO) is a stock option that does not qualify for treatment as an incentive stock option under the Internal Revenue Code. Accordingly, when the option is exercised, the holder will pay ordinary income tax on the difference between the exercise price and the grant price.

Non-Solicitation Agreements are usually in employment agreements to prevent the contracting employee from soliciting the company’s other employees and the company’s customers for a competing business venture.

An Option Plan is a plan created by a company to issue stock options to its employees and service providers.

An Option Pool is a group of shares reserved by the company for long-term compensation to management and employees.

Ordinary Income Tax is a tax on income at rates published by the IRS. Ordinary income tax is generally significantly higher than capital gains tax.

Outstanding Shares refers to the number of shares that a company has issued to shareholders (including founders, investors, advisors, and option holders).

Overhang is when preferred stock shareholders’ liquidation preference is greater than the amount of proceeds the company receives for liquidation. If there is overhang, none of the proceeds will be disbursed to the common shareholders.

Par Value is the the initial value of a single share, and the lowest sales price a startup can receive for its shares. Typically, when a company first organizes, the shares have no or a nominal par value such as $0.0001.

Participating Preferred Stock is preferred stock that receives a liquidation preference, or a priority right upon the company’s liquidation (exit).

A Partnership is created, without filing anything with the state, when two or more individuals go into business for profit. Partners are personally liable for all of the partnership’s debts and liabilities, but the partners receive the benefit of pass through taxation. Partnerships are rarely intentionally created now because of other limited liability options that exist.

A Pass Through Entity passes all income and losses it receives to the company’s owners or investors to be taxed at an individual level. Some examples of pass through entities are partnerships, sole proprietorships, limited liability partnerships, and limited liability companies.

Preemptive Rights are given to shareholders, and before the company can issue additional shares, the company must give the shareholder the option to purchase the amount of newly issued shares that would maintain the shareholder’s percentage of ownership.

The Preferred Return is the amount of return the preferred shareholders will receive on the investment. If the preferred return is not met, there is said to be an overhang, and no other shareholders will receive a return.

Preferred Stock is a type of equity security that is preferred or has preferences over the common stock, largely in terms of dividend payments and fixed payments upon a corporation’s liquidation.

Prepayment is the payment in full of an obligation before the maturity date of the obligation.

A Private Company is a company whose shares are privately sold and owned and are not traded on a public market. Unlike public companies, private companies’ stock is often owned by a few shareholders.

Pro Forma is generally a financial statement or cap table provided to investors that shows the company’s financial structure or capitalization structure if certain assumptions are accepted as true.

Pro-Rata means proportional. For instance, if investors have a pro-rata Right of First Offer, then that means each investor will have a right to purchase new securities in proportion to their ownership. I.e. if an investor owns 5% of a company, he/she will have the ability to buy 5% of the securities in the new offer.

Profit means gross revenue minus expenses.

A Profit Interest Plan (Incentive Unit Plan) is used by an LLC to incentivize and compensate service providers to the company, similar to a Stock Option Plan in a corporation. An incentive unit gives the recipient a right to the future profits of the company after the date of the grant (hence, incentive units are also known as “profits interest”).

A Promissory Note is a debt instrument whereby a borrower promises to pay a lender in accordance with terms defined in the note.

A Public Company is a corporation whose securities are traded on a public exchange. These securities must be registered with the SEC.

A Public Offering is a company selling its equity to the public. Public offerings in the U.S. must be registered with and approved by the SEC.

Purchase Price refers to cash and other property/assets paid in a transaction.

A Qsub is an S-Corporation subsidiary of another S-Corporation (parent).

Section 1202 of the Internal Revenue Code provides for beneficial tax treatment for investors who purchase Qualified Small Business Stock (QSBS) in a company. If a stock qualifies as QSBS, investors may exclude up to 100% of the federal capital gains tax associated with the sale of the QSBS, subject to certain limitations. In order for stock to qualify as QSBS, the company and investor must each meet and maintain compliance with a list of certain requirements by the IRS. The primary requirements include, but are not limited to, the following:

1) the company must be a C-Corp,
2) the company must be engaged in a “qualified” trade or business,
3) the company must have less than $50 million in assets at the time of the stock issuance,
4) investors cannot be a corporation, and
5) investors must hold the QSBS for at least 5 years prior to selling.

Given the complexity associated with QSBS requirements, we recommend consulting with legal and tax advisors before taking steps to qualify any stock as QSBS.

Real Property is land.

Recurring Revenue is the measure of revenue components that are recurring in nature. This excludes one-time (non-recurring) fees and professional service fees.

A Redline is a document which has been marked up with comments or modifications and has been “redlined” so that the other party can easily identify the changes.

A Registered Agent is the official “contact person” for a business. A business must officially designate a registered agent to receive and accept any lawsuits, notices, or other legal documents on behalf of the entity. Texas requires every entity to assign a registered agent before it is authorized to conduct business within the state.

Registration is the process of notifying the SEC that the company plans to sell shares to the public and to register the shares with the SEC under the Securities Act of 1933.

A Related Party means an individual or business that is closely “related” to a specified person or entity. Related Persons are usually relevant for securities purposes and contracts between the related person and a company being acquired.

Representations and Warranties are certifications of certain important facts by a party to an agreement to the other party to the agreement.

Representations and Warranties Insurance is commercial insurance obtained by a buyer and/or seller during an acquisition transaction to cover certain indemnification obligations of a seller post transaction. Like most other types of insurance, Representations and Warranties Insurance has a premium payment, deductible, and types of claims that a covered and not covered.

Reserved Shares are company shares that are reserved for some internal purpose and will not be issued to shareholders. Some shares are required to be reserved. For example, if a company issues preferred stock, the company must reserve enough shares for the preferred stock to convert into common shares.

Restricted Stock is ownership shares of a corporation that are unregistered. Because these shares are unregistered, the stock is non-transferable and can only be transferred in compliance with certain SEC regulations. Restricted stock is most commonly granted to executives, directors, and founders of the company. In an LLC, restricted units are the functional equivalent of restricted stock.

A Restricted Stock Purchase Agreement (RSPA) is an agreement issuing restricted stock. RSPAs are typically granted to founders to prevent the founder from leaving the company prematurely and taking a lot of the ownership with her. The RSPA establishes when the shares will fully vest and belong to the founder. Typically, the RSPA will vest over four years with a one year cliff.

Revenue is money that is brought into a company by its business activities (typically from sales).

The Right of First Offer (ROFO) is a contractual obligation by the owner of an asset to negotiate the sale of the asset with the rights holder before offering sale of the asset to any third parties. In the context of startups, this usually gives an investor the right to purchase his or her pro-rata ownership of any new securities issued by a startup. This is a way to prevent ownership dilution.

A Rollup is an acquisition or merger of a smaller company by a larger company in the same market. The larger companies often purchase the smaller companies to optimize their production and distribution channels.

An S-Corporation is a form of corporation that meets the IRS requirements to elect pass through taxation. The corporation can pass income directly to shareholders. S-corporations can be very valuable in limited instances. They are not typically recommended for startups, but may make sense for some small businesses (particularly services businesses). Please consult with an attorney and/or CPA.

SAFE is an acronym for “simple agreement for future equity,” which is an alternative to the issuance of convertible debt.

The Sarbanes-Oxley Act was passed in 2002, largely in response to a number of significant corporate scandals, including Enron and WorldCom. The Act works to protect investors from fraudulent accounting activities and other problematic practices by corporations. You’ll also hear it called “SOX” or “Sarbox.”

A Secondary Buyout is a private sale by a VC or private equity firm of its stake in a startup (or part or all of its entire portfolio) to another VC or private equity firm. See Tender Offer.

A Secondary Sale is a sale where a buyer purchases shares of a startup directly from the startup’s existing shareholders. This type of transaction allows founders and early-stage investors to take some money off the table.

Secondary Shares are shares sold by a shareholder to a third party rather than shares sold by a corporation.

A Section 336(e) Election is a tax election that allows certain types fo taxpayers to treat an acquisition of the equity of a target company (which must be a corporation or s-corporation) as an asset sale for tax purposes.

A Section 338h)(10) Election is a tax election that allows certain types of taxpayers to treat an acquisition of the equity of a target company (which must be a corporation or s-corporation) as an asset sale for tax purposes.

A set of statutory ways in which a corporation may reorganize or structure a restructuring without the transaction being taxable at the time of the transaction. Section 368(a)(1) reorganizations are sometimes used for acquisitions, restructuring, or mergers of companies.

Secured Debt is debt that guarantees some repayment because it is tied to some or all of a company’s assets as collateral. If the debtor defaults, the creditor can obtain a lien against the collateral.

A Security is used to describe a tradable asset of any kind and generally represents an interest of equity in a company. Stock, membership units, and convertible notes are all forms of a security.

The Securities and Exchange Commission (SEC) is the federal regulatory agency that enforces federal securities laws (such as Sarbanes-Oxley, the Securities Act of 1933, the Securities Exchange Act of 1934, and other securities regulation), proposes rules for the regulation of securities, and regulates the nation’s stock and option exchanges. The SEC works to maintain fair, orderly, and efficient markets, protect investors, and facilitate capital formation.

The Securities Act of 1933 was the first federal legislation regarding the registration of the sale of securities. The Act’s extensive registration and disclosure requirements allow potential investors to have all relevant information needed to make informed investments.

The Securities Exchange Act of 1934 regulates the sale of securities on secondary markets. The Act created the SEC and tasked it with regulating the securities markets. In order to protect investors and to provide transparency, stock exchange markets, brokerage companies and broker dealers, transfer agents, and companies wishing to sell securities all must register with the SEC.

A Security Interest is a legal right in collateral given to a creditor. If the debtor fails to fulfill its obligations to the creditor, the creditor can force the sale of the collateral and collect what it is owed from the debtor.

Seller’s Knowledge mean the actual knowledge and/or construction knowledge of the Seller.

The Sellers Representative or Stockholder Representative is an individual or commercial entity appointed to represent the interests of a group of sellers/stockholders after the sale of a target company, usually by means of an equity sale.

Senior Debt is debt that will be paid back before any other debt. It is said to be “senior” to other junior debt that has a lower priority in regard to proceed distributions from a liquidation event.

Seniority means a senior interest or debt has a higher priority than a junior interest or debt.

A Shareholders’ Agreement (SHA) is an agreement among a company’s shareholders that sometimes exists in startups. While most of the shareholders’ rights are laid out in the formation documents, the shareholder agreement may supplement these documents and further provide how the shareholders will vote, solve disputes, and other rights.

A Side Letter is an agreement between a company and a specific investor that alters the terms of the offering documents for that investor only, typically by providing the investor with additional rights or excluding the investor from certain obligations.

The Signing Date is the date a contract or document is signed by the parties, which may be different than the effective date of a transaction.

A Simple Majority means more than 50% of shares or members who can vote to make a decision.

A Single Materiality Scrape is where materiality qualifiers are disregarded when determining if there is a breach, or the amount of damages, but not both items. It is most common to see materiality qualifiers disregarded when determining damages.

Slack is the go-to communications tool for startups. We highly recommend it.

The Small Business Administration (SBA) is a government agency that provides support to small businesses. The mission of the SBA is “to maintain and strengthen the nation’s economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters.”

A Sole Proprietor is an individual who undertakes to engage in business without partners and without organizational forethought. This does not mean that you have one person, but that you have one owner. There is almost never a reason to operate as a sole proprietorship, as a sole proprietorship does not offer the liability protection that an entity does. Please consult with an attorney.

A Spinoff is a type of divestiture in which a division or subsidiary is separated from its parent firm to create a new corporate entity by issuing new shares. These shares are distributed to the current stockholders (shareholders) in proportion to their current shareholdings and may also be sold to the public.

A Startup is a newly formed company. The term can refer to any entity structure and references the company’s life cycle. A startup will generally seek outside capital and plan for a rapid growth trajectory.

The Statute of Limitations is the length of time in a given jurisdiction during which a type of legal claim may be brought.

Stock Options are an option to purchase a fixed amount of shares at a fixed price that typically vest over time.

A Stock Plan is a company’s equity compensation plan. The company issues equity through Incentive Stock Options, Non-Qualified Stock Options, or Restricted Stock Agreements. The incentives are usually tied to achieving a goal or staying with the company for some period of time.

A Stock Power is an instrument signed by a transferor and transferee of stock or membership interests in order to effectuate and reflect a transfer of stock or membership interests.

A Stock Purchase Agreement is a legally binding contract whereby a purchaser (oftentimes an investor) agrees to purchase shares of a company in exchange for consideration. The consideration is almost always cash, but it could be services or a promissory note, or an exchange of some kind.

A Stock Purchase Agreement is a purchase agreement for the sale of stock of a corporation to a buyer.

A Stock Split is when a company divides its shares into additional shares. The total value of the shares remains the same, but each shareholder will own two or three times more shares.

A Stockholder is the same thing as a “shareholder,” or the owner of stock (a.k.a shares) of a corporation. Stockholders can be individuals or entities.

Stockholders’ Consent is when some corporate actions such as the sale of the company require the stockholders to consent to the company taking such action.

Subordinated Debt is debt that ranks lower in priority than another particular debt if a company falls into bankruptcy or has to liquidate. You may also see it referred to as “junior debt,” a “junior security,” or a “subordinated loan.”

A subsidiary is a company that is owned partially or fully by other company.

A Super Majority is a designated percentage (usually 67%) required to take certain actions – usually major decisions like selling the company.

A Tender Offer is an offer by an issuer or a third party to purchase a significant block of existing shares of a publicly or privately traded company.

The Texas Business Organizations Code (TBOC) codifies the statutes that govern for-profit and non-profit entities in Texas.

A Trade Secret is any confidential business information which provides a competitive advantage. Trade secrets are often protected by contract law but are also protected by federal and state statutes. Examples of trade secrets include sales methods, distribution methods, advertising strategies, client lists, and formulas.

The term is used to describe the status of securities that remain subject to forfeiture or mandatory buyback provisions, even after being set aside for, or granted to, an individual. Unvested securities typically transform into vested securities, which are not subject to forfeiture or buyback, over time or upon the meeting of certain benchmarks or conditions specified in a Restricted Stock Purchase Agreement (RSPA).

A UCC Financing Statement is a legal form that creditors file to provide notice of their interest (current or future) in the personal property of debtors. It specifically details about the pledged collateral, the terms of the loan, and whether the loan is secured or unsecured. You may also see this called a “UCC-1” or “UCC-1 financing statement.”

Unaccredited Investor means any investor that does not meet the legal requirements to be an accredited investor.

Short for Action by Unanimous Written Consent, a UWC is a legal document that memorializes the unanimous consent of the board of directors and/or members of a corporate entity on a specific issue or action.

Unsecured Debt is debt that is not backed by collateral in any of the assets of a company. Since the debt is not secured by any specific assets as collateral, any debt secured by specific collateral will take priority over the unsecured debt in the event of dissolution of the startup and sale of its assets.

Valuation is the process of determining a company’s worth. Valuations can be determined as multiplies of the company’s metrics or comparisons to other companies that recently valued at certain amounts.

Venture Capital is capital provided by investors to startups. Startups are inherently risky due to their likelihood of early failure. Because of the high risk, investors may achieve greater returns.

Venture Capital Funds are investment funds that invest in startups and seek high returns in exchange for the risky nature of investing in startups.

A Venture Capitalist (VC) is a person whose job is investing in startups – a professional investor, so to speak. Venture capitalists work for venture capital firms.

Venture Debt is a bank lending to startups. Because startups are so risky, they generally do not qualify for traditional bank loans until much later in their life cycle. There are, however, a handful of banks who will lend to startups as part of a large venture round.

Venture-Backed Startups are startups receiving venture capital funding. Most companies do not receive venture capital in early rounds of financing until they have proved the company is viable.

Vested refers to the amount of equity that a recipient (i.e. an employee) owns and is no longer subject to forfeiture. Typically, stock options “vest” as the employee continues her employment with a startup, meaning that the employee can now exercise the options and own the stock outright.

Vesting is the period of time that securities (usually stock options) may be subject to forfeiture or repurchase based on meeting certain time or milestone criteria. Vesting co-founder equity helps to protect the company’s equity – so that a departing co-founder doesn’t depart with a lot of equity, but rather only the equity that has vested.

A Vesting Schedule is the timeline over which a stock recipient’s equity (usually stock options) vests. The typical vesting schedule is four years with a one year cliff. See Four Years with a One Year Cliff.

Voting Rights are the rights and/or obligations of a shareholder(s) to vote on certain corporate matters.

A Warrant is a security that gives the warrant holder the right, but not the obligation, to buy or sell a security at a certain price before a set expiration time or milestone.

Example:

We used a warrant for a few additional shares as a kicker to get the deal done.