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EQUITY CROWDFUNDING GLOSSARY


 

*Accredited Investor

As defined in Rule 501 of Regulation D, of the Securities Act of 1933, accredited investors are:

  • A bank, insurance company, registered investment company, business development company, or small business investment company;
  • An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or RIA makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • A charitable organization, corporation, or partnership with assets exceeding $5 million;
  • A director, executive officer, or general partner of the company selling the securities;
  • A business in which all the equity owners are accredited investors;
  • A person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the person’s primary residence;
  • Those with income exceeding $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 in each year, as well a reasonable expectation of the same income level in the current year;
  • A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

 

ACH

A payments system run by the National Automated Clearing House Association that is used to transfer funds for payroll, direct deposit, tax refunds and other services from one bank account to another. Annually it supports more than 23 billion U.S.-based transactions, with a total worth exceeding $40 trillion.

 

*Angel Investor

An affluent individual who provides capital for a startup, usually in exchange for convertible debt or an equity percentage. Angels sometimes organize themselves into groups or networks in order to share contacts and knowledge. See accredited investor.

 

*Audit

A third-party, independent and qualified inspection of an individual’s or organization’s accounts, generally according to accepted accounting principles (GAAP). Under Title III of the JOBS Act, companies that are raising over $500,000 must have audited financial statements.

 

Bad Actor Check

Verification that an investor is not a “Bad Actor.” The SEC ruled in September 2013 that individuals labeled as bad actors cannot participate in securities offerings, or else a company will be disqualified from crowdfunding exemptions. Individuals subject to this check include people with a large degree of involvement with the founding and management of a fund, such as executive team members, investment managers and direct or indirect owners of 20 percent of more of a fund’s outstanding equity securities.

 

*Broker-Dealer

Financial services firms registered and licensed by the SEC to buy and sell securities on behalf of clients. Individuals selling or placing such securities must be likewise registered with the SEC. Businesses offering securities to the public must generally do so through a registered broker-dealer.

 

Business Model

The operational strategy implemented by a company to generate revenue and profit. Business models incorporate revenues, expenses and other core business functions.

 

Business Plan

A document that lays out a detailed picture of how a business will execute its goals from a financial, operational and marketing standpoint. The business plan considers budgets, financing, market analyses and other relevant strategies, and is used to project expenses and revenues over a certain period of time.

 

*Carried Interest

Carried interest is a share of the profits on the increased value of an investment made by an investment fund, typically private equity vehicles. Such profits are taxed differently than regular income, so carried interest often represents the lion’s share of a fund manager’s compensation.

 

*Closing Documents

The legal documentation surrounding a company’s financing, including but not limited to a subscription agreement, purchase agreement, risk factors etc. that provide detailed information about the investment, the company and the parameters of the security being issued.

 

*Conversion Discount

Usually contained in convertible securities such as convertible notes or preferred stock, this mechanism gives an investor the right to convert the face amount of the convertible security, plus interest, into common stock of the issuer at a reduced price or a discounted percentage to the purchase price paid by the investors in the subsequent equity round.

 

*Convertible Note

A debt security structured as a loan and often used by companies and investors who want to delay discussion of a company’s valuation for a later date. The outstanding principal of the note, plus interest, converts to equity of the issuer when a later round of funding occurs or the maturity date is reached. Convertible notes are usually unsecured, and can be customized among participants in a single round. See also Conversion Discount and Valuation Cap.

 

Cooling-off Period

Pertaining to newly-signed contracts, this term refers to the period of time both parties have to release themselves from any obligations without penalty. Federal law usually requires a period of three days, but this can be different depending on the transaction. Also, not every contract has a cooling-off period.

 

*Crowdfunding (Rewards based, donation-based, equity)

Crowdfunding essentially refers to the use of online channels and networks to raise money. The Internet enables very small amounts of money to be raised by very large numbers of people quickly and cheaply, giving rise to multiple forms of crowdfunding. With rewards-based crowdfunding, companies provide early backers with a reward, often an example of their product or service once they’ve raised enough money to make it, in return for support. Donation-based crowdfunding funds primarily social causes, the arts and non-profits in much the same way, with backers provided with recognition, t-shirts etc. in return for their donation. In both these cases, amounts to the firm tend to relatively small and no stake in the underlying organization or company is transferred to the backer.

Equity crowdfunding, on the other hand, refers to the online solicitation and sale of securities issued by a company. Backers of a firm become debt- or shareholders of the business, not just customers or users, typically resulting in a percentage ownership. Because of this distinction, equity crowdfunding comes under significantly greater regulatory oversight than other types. See debt crowdfunding.

 

Debt Crowdfunding

A type of crowdfunding under the equity-crowdfunding umbrella. Under debt crowdfunding, the company raising money does not sell shares, but instead borrows money from the crowd. The individuals lending the money receive the company’s legally binding commitment to repay the loan at certain time intervals and at a certain interest rate.

 

*Debt Financing

Debt financing is a type of loan provided to a business in return for an interest rate, plus a security collateral in case the loan is not repaid. These loans include promissory notes, bonds, straight loans and convertible bonds.

 

Debt Instrument

A physical or electronic document that enables the transfer of debt obligations. Debt instruments such as notes, bonds, mortgages and leases are a promise to repay a lender in accordance with terms of a contract between a lender and a borrower.

 

Diversification

A technique employed to manage risk by mixing a variety of investments within a single portfolio. Diversification smooths out risk because the positive performance of some investments will offset the negative performance of others, and on average, will yield higher returns at lower risk.

 

*Dilution

The decrease in the percentage ownership of existing investors when new investors come into a company. Dilution occurs to the ownership percentage and value because, when the number of existing shares increases, and existing stockholder will own a smaller, or diluted, percentage of the company, making each share less valuable. Some investors insist on anti-dilution provisions when making early-stage investments, designed to ensure their percentage ownership of a company remains intact regardless of how much subsequent capital is raised.

 

*Due Diligence

Due diligence is the research conducted on a company by a potential investor or acquirer in order to determine the accuracy of its records and its business model viability. It is the financial equivalent of kicking the tires and can become extremely detailed in scope and depth.

 

Early Exit

When investors cash out of a previous investment, often by way of an initial public offering (IPO) or an acquisition by a larger player in the industry.

 

Equity

In relation to crowdfunding, equity refers to a stock or other security that represents a share of ownership in a company. Equity is calculated by subtracting the value of a company’s liabilities from the value of its assets.

 

Equity Crowdfunding

See Crowdfunding.

 

*Exemptions

Since every state as well as the federal government (through the SEC) tightly regulates how equity or debt securities may be sold to the public, startups must qualify under one of several Regulation D exemptions from registration requirements if they wish to avoid the expense of a fully securities registration.

Reg D, Rule 506(b) – Companies using this exemption can raise an unlimited amount of money from accredited investors and a maximum of 35 unaccredited investors. Virtually all startup investing was conducted using this exemption until late 2013. Companies using Rule 506(b) may not advertise their fundraising, known as “general solicitation”.

Reg D, Rule 506(c) – Companies using this exemption are permitted to raise an unlimited amount of capital from accredited investors and are allowed to advertise their fundraising to the public as long as they verify that all their investors are accredited.

4(a)(6) – Regulation – This exemption allows companies to raise up to $1 million per year from an unlimited number of investors. Investors do not have to be accredited, but how much they can invest into companies using this exemption is limited to either the net income or net worth of the investor, whichever is higher. If the higher number is over $100,000, the investor is allowed to invest 10% of it each year. Otherwise, it’s 5%.

 

*FINRA

The Financial Industry Regulatory Authority (FINRA) is the independent regulator for U.S. securities firms in the U.S, including broker/dealers and registered investment advisors.

 

Forward Looking Statement

A statement that reveals what management believes about future business conditions. The SEC requires companies to include disclaimers on these kinds of communications with investors.

 

*General Solicitation

For 80 years, companies were not allowed to publicly advertise it is seeking investors. Title II of the JOBS Act, implemented on September 23, 2013, removed this ban, giving companies the ability to promote their crowdfunding campaigns on social media and online. To comply with the new rules, companies must complete and file a Form D with the SEC at least 15 days before starting their general solicitation, and must file an amended Form D within 30 days of closing their fundraising round. Startups must also take reasonable steps to ensure their investors are accredited.

 

Illiquid

Assets that cannot easily be sold or exchanged for cash. Some examples of illiquid assets include houses and certain types of debt instruments – as opposed to liquid assets stocks, bonds and commodities that are easily traded on capital markets.

 

Intermediary

In the financial world, this refers to the middleman between the two parties (buyers and sellers) of a transaction. Banks, broker-dealers, mutual funds and insurance companies are examples of typical financial intermediaries.

 

Issuer

A business entity that issues and sells securities as a way to finance its operations.

 

*JOBS Act

The Jumpstart Our Business Startups Act of 2012 created modified securities laws in order to support capital formation for small businesses. Titles II and III of the Act are the most important.

(note: addition to this) Title II, enacted in September 2013, allows private companies to raise funds publicly by spreading the word and taking investment from accredited investors online. As of October 2015, Title III allows unaccredited investors to participate in equity crowdfunding investments as well.

 

Lean Startup

A method and philosophy for developing new businesses, attributed to a 2008 book authored by Eric Ries. The approach draws from lean manufacturing principles that stress resourcefulness and the ability to make rapid changes when bringing a new product to market.

 

Liquidity

A term that describes how easily an asset can be converted into cash.

 

Market Validation

A process that validates a product or business concept for a potential target market.

 

Offer Document

See Prospectus.

 

Offering

The sale of securities by a company trying to raise money.

 

*Pitch Deck

A summary of a company’s investment opportunity, usually in the form of a PowerPoint presentation. These are concise, clear explanations of company’s business plan and competitive advantages, and often include financial projections. The pitch deck is often the first document requested by potential investors.

 

Platform

A website or software through which investors and companies can conduct transactions.

 

*Portal

Crowdfunding portals are websites where crowdfunding opportunities are presented to users. Equity crowdfunding portals also often “curate” deals for presentation to investors, providing dashboards, search/sort capabilities and the ability to download documents. Some may also help set up meetings with management, as well as with the fulfillment and settlement of the actual offering.

 

*Post-Money Valuation

The valuation of a company AFTER an investment has been made. This is always equal to the pre-money valuation plus the total amount of new investment.

 

*Pre-Money Valuation

The valuation of a company before any new investment has been made.

 

*Private Placement

The sale of securities to a small group of accredited investors or institutions in an offering exempt from registration with the SEC.

 

Prospectus

A document an issuer must file to the SEC that provides details about an investment offering, and helps an investor make an informed decision.

 

Rescission Right

An individual’s right to return to pre-contract circumstances, in the event the courts do not recognize a contract as legally binding due to errors and other reasons.

 

*Regulation A+

The final rules pertaining to the JOBS Act section that allows private companies to make exempt public offerings of up to $50 million of securities within a 12-month period. These final rules implement Title IV of the JOBS Act and provide for two tiers of offerings:

  • Tier 1, which would consist of securities offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer.
  • Tier 2, which would consist of securities offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

These rules place a variety of limits on post-financing sales by investors and affiliates, and companies may be required to provide audited financial statements, file annual or quarterly reports, as well as a number of other restrictions.

 

*Regulation D

Part of the Securities Act of 1933, Regulation D governs registration exemptions available for companies that are raising capital. Reg D allows smaller companies to raise capital through the sale of equity or debt securities without having to register them with the SEC, saving tremendous time and costs for the issuer.

 

Revenue Projection

The estimated amount of revenue a company will generate over a specific accounting period.

 

Risk Statement

A statement that provides an accurate assessment of the potential for risk and how it may impact a business or financial ­transaction.

 

Secondary Markets

Markets such as the New York Stock Exchange and the NASDAQ, where investors purchase securities from other investors, rather than from the original companies that issued them. Any profit from the transaction price, settled by supply-and-demand forces, goes directly to the investor instead of the company.

 

Secondary Trading

Trading activity that occurs in a secondary market.

 

Securities

A financial instrument that represents ownership in a business.

 

Securities and Exchange Commission (SEC)

A U.S. government agency created by Congress to regulate the securities markets and protect investors from fraud and deception. The SEC is composed of five commissioners serving staggered five-year terms, and the commission’s intention is to promote full public disclosure and monitor securities transactions and activities of financial professionals.

 

*Seed Round

The first outside capital raised by a startup. In many cases, this capital comes from family and friends, angel investors or startup accelerators, and is rarely more than $250K. Seed capital can be equity or debt.

 

*Series A Round

The first bona-fide equity financing by a company, often with venture capitalists as investors. Subsequent rounds, hopefully at higher valuations, are named alphabetically (Series B, Series C, etc.).

 

Shares

A financial asset that typically represents a unit of ownership in a business in the form of a physical paper or electronic records. A shareholder does not have direct control over business operations, but does get a portion of any profits in the form of dividends.

 

*Startup Accelerator

Programs that provide companies with a small amount of seed capital, coaching, mentors, contacts and back office support, typically for 3 to 6 months, in return for equity stakes. Startups must apply and be accepted into such programs, which often end with “demo days” at which they pitch their product or service to a group of investors and venture capitalists. Most popular with technology startups.

 

Stock Portfolio

A collection of individual stocks and other financial assets owned by an investor and is either self-managed or managed by financial professionals.

 

Title II

See JOBS Act.

 

Title III

See JOBS Act.

 

Title IV

See Regulation A+.

 

*Term Sheet

A summary of the major points in a business agreement or transaction. Term sheets are typically drawn up after the parties have agreed on the substantive elements of a deal, and are used as the basis for drawing up legal documents, contracts, etc. Term sheets include such things as form of security, amount raising, valuation, interest rate, anti-dilution provisions, etc.

 

*Valuation Cap

Used in convertible notes to place a ceiling on the valuation at which the note will convert to equity upon a subsequent equity financing. A valuation cap guarantees an investor will convert to equity at no higher than a set valuation, regardless of where the subsequent round eventually comes in.

 

Venture Capital

A sought-after source of funding for startups that can make a case to investors that the business will have long-term growth potential. Venture capitalists accrue higher risk, but receive higher returns if they invest in a successful company at an early stage.