Before embarking on any journey to a foreign land, it’s important to know a bit of the language spoken at your destination. It’s even more important to have a shared understanding of terms when you embark on investment crowdfunding. When people start throwing around terms like burn rate, moat, and runway, you don’t want to have to surreptitiously Google those terms before you respond.
So let’s define some terms, shall we?
Angel investor: Usually a high-net-worth individual who invests in startups, generally in exchange for equity. Angel investors are sometimes friends or family members, but often they are simply investors who choose to devote a certain percentage of their portfolio to help innovative, early-stage companies launch their business.
Accredited investor: An individual or entity that is allowed to invest in securities that have not been registered with the Securities and Exchange Commission (SEC). Such investments are considered higher risk, so they’re reserved for those who are considered more sophisticated investors. To be an accredited investor, individuals must have a net worth of more than $1 million, or at least two years of annual earnings exceeding $200,000 (or $300,000 with a spouse). The JOBS Act of 2012 opened up equity crowdfunding so that retail, or common, investors (i.e., unaccredited) could invest in startups, though the amount of such investment is restricted based on level of income or net worth.
Burn rate: The amount of money a startup is burning through each month. The burn rate is determined by subtracting expenses from revenue. If a company is spending $50,000 a month more than they’re earning, that amount is the burn rate.
Exit: The hoped-for end game for startups. Exits can include an IPO or the startup being acquired — in either scenario, a successful exit means the investors and anyone else who owns equity will make a profit.
Lead investor: The definition of this term changes depending on the context. It can mean the first investor, the person who invests the most, or a person who invests and then agrees to represent and organize the other investors. That last definition is the one used in the equity crowdfunding context. According to WeFunder, the lead investor directs the votes of the other investors, and when the founder needs authorization from investors for the company’s actions, he or she only needs that authorization from the lead investor.
Moat: Describes a company’s advantages over competitors, including low cost, proprietary technology, and brand recognition.
Pre-money valuation: The value of a company before any outside investment has been made.
Post-money valuation: You guessed it! The value of a company *after* an outside investment has been made.
Runway: The number of months a startup could survive without additional investment given its current revenues and expenses. Ideally, a startup would have 18–24 months of runway in order to successfully launch.
Seed round: The first official stage of raising funds in exchange for equity. Investors at this stage are often family members, friends, or associates of the founders, but these initial funds could also come from angel investors, venture capitalists, or incubators. For some companies, seed funding is all that’s needed to launch a business, but most startups go on to additional rounds of funding.
Series A funding: The initial significant investment, often coming from a venture capitalist, that comes after the seed funding. Usually such investments happen after a company has some sort of track record or performance indicators. These indicators could include revenue, but many startups require Series A funding to begin generating revenue. Other indicators could include a committed audience, successful (and patented) prototypes, and founders with other successful exits under their belts.
Testing the waters: A method of gauging investor interest before officially filing with the SEC and launching a campaign. An SEC rule that went into effect March 2021 allows companies to pitch to prospective investors and list a project on a crowdfunding platform before completing compliance work, though there are strict rules that must be followed in such communications. Investors can reserve spots, but those reservations are non-binding at that stage.
Unicorn: A privately held startup valued at $1 billion.
This vocabulary sampler is a good start, but be sure to take a deep dive into the world of investment crowdfunding before you take your first steps down that road. Safe travels!