Alternative Minimum Tax (AMT)
Cap on the amount of income deduction that can be claimed in an income tax filing, which is filed using IRS Form 6251. Certain forms of deduction, including Incentive Stock Options, are always subject to the Alternative Minimum Tax, while income tax filings that claim an excess of deductions may be entirely subjected to the Alternative Minimum Tax.
An option that allows the option holder to exercise without actually paying cash for the options. Shareholders generally utilize this method if they plan on selling the shares immediately after exercising the options.
Employee stock vesting agreements generally have a cliff, usually one year, before which no employee stock options vest.
A type of equity security, contrasted with preferred shares. Common stock is most frequently issued to founders, management, and employees. In a liquidation event, preferred shares generally take priority over common shares.
An official document that shows the capital structure of a company, including the specific ownership level by investor. Generally used to view the percentage ownership that each investor or employee owns of a certain company. See a cap table example here.
Employee Stock Ownership Program (ESOP)
A pool of options that is reserved for future employee compensation packages.
A form that must be returned to the company, along with any additional required items (including money or shares), in order for vested shares to be issued.
Incentive Stock Option (ISO)
Stock options that are generally only granted to employees or advisors. Generally, the option holder does not pay income tax on exercise - capital gains are paid based on when the stock is sold. The difference between the exercise price and the value at exercise is considered for determining implications of the "alternative minimum tax". Read our blog post for a deeper dive on startup employee compensation.
The ability of an asset to be freely transferred with minimal interference from the issuer. Public equity is deemed to be extremely liquid since there are many buyers and sellers, while stock in private companies is generally much less liquid since the buyers and sellers are more limited.
A period of time that must elapse before the holder of a specific security can transfer or sell the security.
Non-Statutory Stock Option
Options that can be granted to anyone, including contractors or consultants. Generally taxed as ordinary income at the time of exercise based on the difference between the exercise price and the price paid for the options.
A contract that requires one party to transfer the cash proceeds from a liquidation of equity to another party in exchange for cash received prior to the liquidation event.
The acquisition of stock, or other securities, from sources other than the issuer. Under this definition, all transactions that are not part of a corporate transaction, such as an IPO, primary fundraising round, or spinoff, are considered secondary transactions.
Not always one document, the "Separation Agreement" refers to the entire package of rights and considerations when an employee amicably leaves a company. In addition to severance pay, separation agreements often include provisions about non-disparagement, non-disclosure, and vesting of equity.
Generally, when something that is promised is delivered and ownership is officially granted to the recipient. For employees, shares generally vest according a predetermined schedule. Vesting effectively means that employees only receive their equity compensation after a period of employment to ensure alignment of interest between the company and the employee. The current market standard for vesting schedules is 4 years with a one-year "cliff". Typically, this means that 25% of the grant will vest after one year, and the balance will vest in equal monthly installments over the following 36 months. See our blog post on vesting schedules for additional information.
Rights of an investor or shareholder relating to control over the company's affairs. Control rights typically relate to voting or designation of board seats, voting (e.g., does a class of securities give the holder 10 votes per share?), and certain actions (e.g., incurring indebtedness) which require the consent of a majority of a certain class or series of security.
Adverse Change Redemption
A right of a shareholder that requires the company to redeem a class of securities in the event the company experiences a material adverse change to its prospects, business or financial condition. This is a negotiated right that you expect to see in down economic cycles where investors tend to have more bargaining power than the companies seeking to raise capital. Startups should seek to avoid such a provision when negotiating a funding round for a variety of reasons, including the vagueness of the "material adverse change" trigger.
Considering a class of securities under the assumption that all of the that class has converted into another class of securities. In the venture context, this is usually with respect to preferred stock, which converts into common stock automatically in some instances and at the election of the preferred stock holder in others. Preferred stock often votes on matters on an "as-converted basis".
When all classes of preferred stock have equal payment rights in the event of a liquidation
Pro rata right
The right of a shareholder to purchase shares in a future financing round equal to the percentage of ownership the shareholder currently holds at the time of the financing.
When stock is returned to a company by departed employees whose stock has not yet vested.
When different classes of preferred stock have senior rights to payment over other classes of preferred stock. Also known as Senior Liquidation Preference
Senior Liquidation Preference
An entitlement given to a certain class of shareholders that gives them a higher liquidation preference over other shareholders. Also known as Stacked Preference
Financial incentives that discourage founders and early employees from leaving a company before certain dates or milestones. Often found in an acquisition scenario, an example would be a cash or equity payout by an acquiring company that is earned over time.
The process performed by prospective investors to assess the viability of an investment and confirm that the information provided by the company is accurate.
Non-disclosure agreement (NDA)
An agreement issued by entrepreneurs to protect the privacy of their ideas when disclosing those ideas to third parties such as investors.
Refers to a company's stock currently held by all of its shareholders, including shares held by institutional investors and restricted shares owned by a company's executives. This number is used to calculate key metrics such as a company's market capitalization, earnings per share, and cash flow per share.
Fully Diluted Shares Outstanding
The total number of shares that would be outstanding if all possible sources of conversion (convertible bonds and stock options) were exercised.
Exercise Price (also known as Strike Price)
The amount that must be paid to execute your options. Generally, the exercise price is pegged to the "Fair Market Value" on the date of issuance, rather than the vesting date.
A company that has received an investment from a venture capital fund becomes a portfolio company of that fund.
The reorganization of a company's capital structure.
Return on Investment (ROI)
The proceeds from an investment during a specific time period, which are calculated as a percentage of the original investment. Also net profit after taxes divided by average total assets.
Rights of Co-Sale With Founders
A clause allowing venture capital investors to sell shares in a company at the same time that the founders decide to sell.
Presentations usually made in several cities to potential investors and other potentially interested parties. A company will often use a road show to create interest from investors before its IPO.
A contract that sets out how the company will be operated and the shareholders' obligation and rights. It often provides protection to minority shareholders.
A right to purchase or sell a share of stock at a specific price within a specified period of time. Stock options are often used as long term incentive compensation for management and employees at high-growth companies.