Internal Revenue Code Section 409A is a set of IRS (U.S. federal) regulations that govern the treatment of “non-qualified deferred compensation plans.” Deferred compensation plans promise to pay employees or other service providers in a subsequent year for work performed now. For start-ups, the most important rules within 409A relate to the provision of options as compensation for service providers and employees.

409A requires the holder of an option granted at an exercise price below fair market value (FMV) of the underlying shares to pay income taxes on the spread between FMV and the exercise price during the vesting period. This means the holder would pay taxes on options they could not yet exercise or sell, and the income would be taxed at the ordinary income tax rate, instead of a more favorable capital gains rate. Furthermore, an additional 20%+ federal tax applies and, in some states, yet another 20%+ tax is leveled. If the company fails to withhold these taxes, it could be liable for the taxes due, plus penalties and interest.

To avoid these tax consequences, some companies choose to issue Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs/NQSOs) There are two different types of options with more favorable tax consequences for employees and employer alike:

The period over which interest earned on a debt instrument is calculated. For example, if the accrual period on a $100 note bearing 5% simple interest is annual, $5 of interest would be earned in the year. If the accrual period is 6 months, the interest would be earned in increments of $2.50 after 6 and 12 months. For compound interest, if the compounding period is shorter than the accrual period, the amount of interest due at the end of the accrual period will be higher. For example, a $100 note bearing 5% annual compound interest compounding every six months with an annual accrual period will have interest earned after one year of $105.06. This is because, due to compounding, the $2.50 of interest earned after six months earns an additional $0.0625 of interest over the remainder of the accrual period. Interest may be payable at the end of the accrual period or may be allowed to accumulate depending on the terms of the debt.

To accumulate at a particular rate over time, generally referring to interest or dividends.

An individual investor that contributes capital to a start-up business. Most angel investors participate in early-stage funding through investments in equity or convertible debt securities. Angel investors often pool capital through angel networks to make larger investments and share risk.

Representation of a company’s capital structure or one or more components of the capital structure assuming all convertible securities including preferred stock, convertible notes, SAFEs, etc. are converted to common stock. The conversion is assumed on a hypothetical basis to calculate the share of voting rights, dividends, or value each security holder is entitled to receive.

The number of shares of a particular share class a company’s charter permits to be issued (cumulatively). Authorized shares include authorized but unissued shares the company may elect to issue in the future. The number of authorized shares can be amended by the Board of Directors when the company needs to issue more shares that will bring the cumulative number of shares issued above the number that has been authorized. Redemption of previously issued shares reduces shares outstanding but does not impact the number of authorized shares (unless the redeemed shares have also been canceled). Authorized but unissued shares do not count toward the calculation of fully diluted shares because they do not create new ownership claims on the company until they have been issued.

For example, a company’s charter authorizes 10 million shares. It has issued 8 million shares to date and plans to issue 4 million more. The Board must amend the shares authorized to be at least 12 million to facilitate the new issuance. Later, once the company has cumulatively issued 12 million shares, it redeems 500 thousand shares. The authorized shares remain 12 million. The number of shares issued remains at 12 million. The number of shares outstanding becomes 11.5 million.

Date at which the Board of Directors of a company approves an issuance or grant of securities. This is important to track for stock options, for example, because board approval must take place within a certain period of time to qualify the options for favorable tax treatment.

Cancellation of a security such as a share of stock renders the claim of the security on the company and any corresponding rights null and void. Securities might be cancelled if issued due to a clerical error. Under most circumstances, a company cannot cancel outstanding securities without the holder’s consent. Equity awards such as stock options might be cancelled without remuneration to the holder in the event a particular option is unlikely to have value and the holder wishes to return shares to the employee stock incentive plan pool for other uses.

A cap table is a comprehensive ledger of the financial instruments issued by a company including equity, debt, and other securities. The cap table details the financial claims represented by each instrument and lists who holds them. Stakeholders can make better decisions about financing, investment, and compensation through understanding of the impact of these critical activities on the cap table; these decisions affect the value and proportion of equity held by each investor, employee, and founder. For example, a company’s management needs to understand the dilutive impact of a new equity financing on existing shareholders to evaluate an investor offer. Likewise, prospective investors need to understand the cap table to ensure their terms properly incentivize the company’s founders and employee option holders to grow the business.

The data included for each entry on a cap table could include the following, but the fields required vary by the types of financial instruments a company issues:

Cyndx Owner condenses the detailed information required to build a functional cap table into summary formats to facilitate analysis and understanding. You can easily view your cap table in Cyndx Owner in several useful ways. Holdings on a cap table can be summarized using segmentations such as holder type (e.g., founder or investor), security class (e.g., preferred or common stock), financing round, or individual holder. These segmentations enable decision makers to readily track holdings through relevant categories with shared rights, interests, and incentives.

Capital has many different meanings depending on the context, but for cap tables, capital generally refers to money invested by various parties to fund the operations of a company. Capital includes debt, equity, and other forms of investment that are contributed in anticipation of generating a return.

The composition of debt, equity, and other securities comprising the financial claims on a company (also known as its capitalization or sources of funds). Components of a company’s capital structure are claims seeking returns over time through interest or dividend payments or capital gains and exclude operational liabilities such as short-term vendor payables. A company’s owners typically seek to design its capital structure in order to ensure the business has enough cash to operate and meet its fixed obligations, align the incentives of investors with the business’s goals, and avoid excessive dilution of their ownership.

Stock options or warrants providing the option for cashless exercise enable the holder to exercise the right to purchase stock without paying the exercise price in cash. Instead, the holder receives fewer shares than underly the options or warrants. The number of shares received is determined by dividing the spread between the fair market value (FMV) of the underlying shares and the exercise price divided by the FMV per share. In this way, the holder receives the net value of the securities held without having to pay cash upfront.

For example, assume a holder has 100 options with an exercise price of $10 each and the current fair market value per share is $25. The spread between the FMV and exercise price is $15 per share. The holder must normally pay $1,000 in cash to exercise all the options to receive 100 shares worth $2,500 representing a position with a $1,500 aggregate spread or profit. With cashless exercise, the holder may instead elect to receive 60 shares worth $1,500 without paying any cash upon exercising the options. As of the exercise date, the net value received by the holder is equivalent, but the holder foregoes any future appreciation on the 40 shares they could have purchased at the exercise price. Cashless exercise is therefore less dilutive to the ownership of the other shareholders than normal exercise.

Return metric measuring either the market value of an investment or total cash proceeds received from an investment as a multiple of the cash invested. C-on-C/MOIC multiple describes the magnitude of return but does not provide information on how quickly returns were generated.

Date when definitive agreements for a capital raise are executed and funds invested are transferred from investors to the company. In a particular financing round, some investors may fund before others, so the date the first funds are received is the initial closing date. The date when all funds committed for a round are transmitted and all investors in a round have executed definitive documents is the final closing date. Often all closings will happen on the same day, so these dates may be the same.

Also known in some jurisdictions as ordinary shares, voting shares, or equity shares, common shares are a form of equity (i.e., ownership) interest in a corporation. Common shares are typically held by founders and employees in a start-up, while venture capital and angel investors tend to invest through preferred shares with different rights. In the event a company is sold or liquidated, proceeds are paid to common shareholders only after distributions have been made to satisfy the claims represented by debt, other liabilities, and preferred shares. In the event of an initial public offering, preferred shares are usually converted to common shares, and common shares are issued to the new public investors. Common shares are typically issued in a single series or class, but some companies issue multiple classes of common shares with varying voting or other rights. A company’s Board of Directors must approve all issuances of common shares.

Compound interest is a type of interest that is earned not only on the principal balance of a debt instrument but also on accrued (accumulated unpaid) interest. For example, $100 of principal balance earning interest at 5% with an quarterly compound period will bear $5.09 of interest after one year.

t=# of Accrual Periods Elapsed

Describes how frequently interest compounds on a financial instrument. Compounding is when accumulated unpaid (accrued) interest adds to the amount of interest earned going forward. For example, $100 of principal balance earning interest at 5% with an annual compound period will bear $5 of interest after one year. Assume the interest is accrued rather than paid in cash at the end of the year. The following year the interest earned would be $5.25 reflecting the interest due on the original principal and the additional interest earned on the unpaid interest from the prior year. If the compounding occurred each quarter, the future value will always be higher than it would have been with annual compounding, all else being equal.

Convertible notes are a form of debt with a senior position in a company’s capital structure and a feature whereby the notes may convert to equity following achievement of certain milestones. Convertible note investors are primarily interested in the capital appreciation potential of the shares; however, the debt component provides some level of downside protection, enabling holders to claim assets and receive priority in a liquidation. Convertible notes are favored by early-stage angel and institutional investors, while issuers benefit from delaying pricing equity until the business has grown further.

The number of shares issued upon note conversion is usually determined based on the share price/valuation set in the next qualifying round subject to adjustment for conversion discount or valuation cap features described in the terms below. Convertible notes may commonly bear the following terms:

Raising money for a business from a large group, normally undertaken through an online platform like Kickstarter. Crowdfunding can be rewards based or equity based—the latter is subject to compliance with securities regulation because shares are distributed to the funders.

A claim on a business for a fixed amount of cash, usually accruing interest over time, often owed to a bank or investor. Debt instruments may take a variety of forms (e.g., notes, bank loans), which generally require a company to pay interest on a periodic basis with a specification of payment in cash or additional securities. A key feature of debt is that its claims are senior to (i.e., take priority over) claims of equity holders in the event of a sale or liquidation of a company. Accordingly, debt must be repaid in full before any proceeds are distributed to preferred and common shareholders. Debt agreements may require the company to pledge collateral to the creditor, conveying a security interest in assets of the company such as IP, equipment, or bank accounts. Such security interest enables the creditor to take possession of the collateral in the event of a default. Start-ups typically do not issue much straight (i.e., non-convertible) debt due to the high risk of default attending early-stage companies; convertible debt, however, is commonly issued by start-ups because it grants investors upside participation through equity exposure.

Reduction in the fraction of ownership in a company held by existing investors as a result of new shares being issued to a new investor or due to option exercise. Options and warrants are potentially dilutive instruments, as they give the holder the right to purchase additional shares; dilution occurs when holders exercise this right.

Dividends generally refer to distributions made to common or preferred shareholders as a distribution out of a company’s earnings. Start-ups rarely pay elective dividends to common shareholders, but preferred stock commonly has a fixed dividend expressed as a percentage of the investment amount, called a yield. Preferred dividends can be cumulative or non-cumulative. A non-cumulative dividend does not have to be paid in future years if it is not paid in the year it is earned, whereas a cumulative dividend accumulates over time if unpaid in a given year. Cumulative dividends may, depending on the security’s terms, compound if unpaid and thus increase the dividends payable in future years. Venture capital investors generally do not expect to actually receive cash dividends but instead use them to increase their equity exposure to a company over time. In some cases, accrued dividends are payable upon conversion of preferred shares into common stock or are added to the liquidation preference in a liquidation. More frequently, accrued dividends are not paid if the preferred shares are converted to common. Another variation on dividend terms gives companies the option whether to pay preferred dividends in cash or in common shares priced at fair market value.

Ownership interests in a company giving the holder rights to share in the business’s profits and in some cases to exercise control. Equity interests are represented by common shares, and in some cases, preferred shares. The value of equity in a company represents the residual claims on the value of an enterprise after debts and other liabilities are settled. Equity holdings are riskier than debt because they represent a residual rather than a fixed claim on a business’s underlying assets, but they offer the potential for dividends and capital appreciation if the business performs well. Certain forms of debt, such as convertible notes, can be converted to equity under certain circumstances and thereby provide the holder with additional upside.

An equity incentive plan (EIP) is a plan adopted by a company’s Board of Directors that provides for employees to receive share-based compensation. Granting employees a financial stake in the success of a company aligns their interests with founders and outside investors. Furthermore, an EIP enables a company to offer value to employees without depleting limited cash resources. Adopting a compliant EIP is a requirement to qualify for an exemption from SEC registration; it is critical when issuing share-based compensation in order to avoid violating securities laws or taking on a heavy regulatory burden. Shares and options issued through an EIP must also comply with applicable tax rules such as Internal Revenue Code 409A. There are three primary ways to compensate workers through an ESIP:

A company’s Board of Directors will authorize a certain number of shares under which can be issued under an EIP, and the company can reserve a certain number of shares for issuance as restricted shares or shares underlying stock options. The shares reserved, often referred to as an option pool, are generally treated as a component of fully diluted shares in negotiating equity financing.

The Equity Incentive Plan Shuffle is, in a given financing round, the percentage of the post-money valuation assigned to the increase in the unallocated option pool for new employees that dilutes the pre-money owners. The shuffle reserves additional common shares for grants to employees which may be needed in the future to pay share-based compensation. Expanding the option pool in the pre-money dilutes the ownership of the existing shareholders and increases the number of pre-money fully diluted shares. This reduces the share price for the new investors and thus increases the number of shares post-money investors receive for a given amount of cash invested.

The shuffle benefits the new investors by effectively allocating to the pre-money holders the dilutive impact of share-based employee compensation expected to be incurred over a certain period of time after the financing. Anticipating the expected dilution through an increased fully diluted share count at the time of the financing gives the new investors a larger share of the company upfront than they would otherwise be receiving.

For example, if a company has a pre-money valuation of $8 million with 6 million diluted shares outstanding prior to the shuffle, the price per-share would be $1.33. An investor investing $2 million would receive 1.5 million shares or 20% of the company. The pre-money shareholders would own 80% of the post-money shares. The post-money valuation would be $10 million.

With a 20% shuffle, the investor would receive 20% of the post-money shares, 20% would be reserved to the unallocated equity incentive plan, and 60% would be the shares held by the pre-money owners. This would imply 10 million total post-money shares. Since the post-money valuation is still $10 million, the implied share price would be $1.00. Accordingly, an investor investing $2 million would receive 2.0 million shares.

The value of a company at exit (sale of the company also referred to as a liquidation) to be distributed to investors. Within Cyndx Owner, this represents the total cash available to repay debt, make distributions to shareholders, and settle warrants and options. For a given holder or holder category, this cash distribution is referred to within the Owner platform as the net payout.

The current accepted value of a business or a security such as a share of common stock (i.e., how much money it would be expected to sell for in the market). FMV of a common share depends on the value of the company as a whole, the claims of other securities senior to common stock, and the number of fully diluted shares. Private companies often obtain 409A valuations to arrive at the FMV of their stock. 409A valuations look at factors like the value of a company’s assets, the present value of future cash flows, and comparable company valuations, among others. FMVs need to be updated annually or each time a material event such as a financing round occurs. 409A valuations of FMV are generally required for issuance of share-based compensation, and the valuations must not be “grossly unreasonable” in order to avoid potentially significant tax penalties.

Generally refers to any contribution of capital to a company by outside investors or lenders. Financing provided by founders is referred to as self-financing.

One in what is typically a sequence of discrete financings in which investors purchase an interest in a start-up company to help fund its growth. The industry uses a specific nomenclature to denote the stage at which each round takes place.

Financing rounds at the various investment stages are as usually described as follows:

A unit of equity that is less than one whole share, fractional or partial shares can arise due to stock splits or formula-based share issuance mechanisms. Often when a formula for issuing shares is used, the document includes a provision to round fractional shares or pay cash in lieu of fractional shares to avoid complexity.

Represents the number of common shares that would be outstanding upon the exercise or conversion of all outstanding preferred stock, options, warrants, and other convertible securities. In other words, fully diluted shares are calculated as the total common shares currently outstanding plus the common shares created when securities convertible into common shares are converted and options and warrants exercisable for common shares are exercised. Warrants or options offering the right to purchase preferred shares are also included because those preferred shares would convert into common. Note that cap tables typically use the total number of shares underlying options authorized for issuance under an equity incentive plan (EIP) to calculate fully diluted shares. This is the most conservative presentation because it assumes all shares reserved under will be granted and will vest.

The date on which share based compensation is awarded to an employee or service provider. An employee stock incentive plan will specify the day which constitutes the grant date to comply with applicable regulations. Vesting usually commences on the grant date. The grant date is important because fair market value (FMV) used in structuring the options or restricted stock must be current as of this date to ensure compliance with relevant tax laws (e.g., section 409A).

Cost of debt financing incurred on a periodic basis payable in cash or securities (e.g., interest paid via additions to the principal balance of the debt) as specified by the debt documents

Invested capital represents the sum of cash contributed by a holder (or holders) of a company’s debt, equity, or other securities (including the exercise price paid to exercise warrants and options). Investment returns for a given security are calculated as a multiple or percentage of the capital invested to purchase that security.

Refer to the order in which distributions take place in a liquidation or exit. In an exit, proceeds are paid out in a certain sequence or “waterfall” that assigns a priority to each claim based on its Financial instruments/securities that are more senior in a company’s capital structure get paid out first. Junior securities get paid out only after each security that is more senior has been paid out. Pari passu securities are paid out on a pro rata basis, meaning equally in proportion to the size of their holdings within their class.

A liquidation is a sale of a company’s aggregate net assets for cash proceeds. In a liquidation, the proceeds are paid out to holders of debt and equity instruments issued by the company according to liquidation preference. The liquidation preference is the order, often called priority or preference, in which the proceeds are distributed. Holders are paid in order of seniority, starting with debt, followed by preferred shares, and finally, common shares. Liquidation can occur under positive or adverse circumstances. The sale of a successful company (an exit) might result in enough cash being generated to pay all indebtedness and preferred shareholders with significant proceeds going to common shareholders and holders of exercisable options and warrants. A liquidation triggered by bankruptcy may result in insufficient proceeds to even repay all of a company’s debt or only enough to repay the debt and a portion of the preferred stock.

Liquidation preference is a term describing the order in which the proceeds of a liquidation are paid out. The term is frequently applied to terms of preferred shares that specify where a particular preferred share class resides in the waterfall of distributions. In a liquidation, the liquidation preference terms of each preferred share class determines the priority in which the classes get paid and how much each gets paid from proceeds generated.

Date at which the company is obligated to repay the principal outstanding on a debt security. The maturity date is sometimes extended with the consent of the lenders.

Securities that provide the holder the right to purchase shares of a company at a designated price referred to as the exercise price. Options usually have a set term or exercise period during which the holder may exercise the right to purchase shares. The date at which the term or exercise period expires is called the expiration date; should the holder not exercise their right to purchase the shares by the expiration date, the option expires worthless. The number and class of shares particular options enable the holder to purchase are referred to as the underlying shares. While options are like warrants, they are usually issued to employees or other service providers unlike warrants which are mainly issued to investors. There are important tax consequences of options grants for companies, service providers, and employees to consider set forth for U.S. companies by section 409A and other provisions of the Internal Revenue Code. Option grants should be structured to be compliant and tax efficient under the 409A rules.

The number of shares in a class that have been issued and not redeemed. Sometimes referred to as “issued and outstanding shares.”

Refers to a conversion of a holder’s securities in which only a portion are converted to another security class (e.g., common shares) and the rest of the holder’s convertible securities remain outstanding.

The valuation placed on a company following the addition of investor money from a contemplated investment. The pre-money valuation plus new investor cash equals the post-money valuation.

A form of equity (i.e., ownership) interest in a corporation with priority over common shares in the exit waterfall distribution (i.e., seniority or “liquidation preference”) and various customizable rights and features. Companies typically issue preferred stock to venture capital funds participating in priced rounds (e.g., a Series A financing). At the time of an exit or liquidation, preferred shares convert to common shares at a specified conversion ratio (typically at a 1-1 ratio for start-up companies).

Cyndx Owner supports the following common terms and features of preferred shares:

The valuation placed on a company before the addition of investor money from a contemplated investment. The post-money valuation less new investor cash equals the pre-money valuation.

A financing round in which equity is sold at a specified share price, which serves to establish a market-based pre-money valuation for a company at a given point in time. Completion of a priced round may commonly serve as the conversion trigger for a convertible note or SAFE security.

The total amount a borrower must repay on a debt instrument by the maturity date. Generally, this is equal to the original sum invested plus any accrued interest that has been converted to principal. A stated interest rate is applied to the principal outstanding during an accrual period to calculate the interest earned on the debt during that period.

Refers to a corporation purchasing shares or other securities it has previously issued to a security holder. A company may have to repurchase securities at a negotiated price, or sometimes it may have the right to effect a repurchase based on a contractually agreed upon price or mechanism defined by the security terms. A share repurchase reduces the number of shares outstanding but does not reduce the number of shares issued.

Shares, usually granted to a service provider or employee, that are subject to time or performance-based vesting (i.e., recipients must earn the shares offered by performing their obligations). Restricted stock can be granted through either restricted stock awards (RSAs) or restricted stock units (RSUs). The Cyndx Owner platform uses the term “Restricted Stock” to refer specifically to restricted stock awards (RSAs).

Any securities transaction except for the original issuance of a security by a company is a secondary transaction. The issuance of securities by a company is referred to as a primary transaction.

General term for a financial instrument including a note, stock, bond, option, or warrant, among others. In the United States, Federal securities laws define what constitutes a security and regulate offers and sales of securities, which either need to be registered with the SEC or qualify for an exemption from registration.

A share is a unit of stock (also called equity) in a company. Shares reflect ownership in a company entitling the holder to participate in the profits and to exercise some measure of control over the company through voting rights or other special rights. Shares are frequently divided into different classes; the most common division is between common and preferred shares. A company can also have multiple classes each of common and preferred shares.

Cyndx Owner tracks allows the user to track certain information regarding a company’s shares from the shareholder register including:

Shares are frequently divided into different classes with different rights and priority of payment. The most common share class division is between common and preferred shares. A company can also have multiple classes each of common and preferred shares. Generally, common share classes only vary with respect to the number of votes each share in a class is entitled to cast on corporate resolutions. Preferred share classes can vary in many ways with different voting rights, liquidation preference, dividend rights, anti-dilution rights, and conversion to common shares, among many other features. Each share class is referred to as a series, so a company’s preferred classes might be called “Series A Preferred Shares,” “Series B Preferred Shares,” etc. and its common classes might likewise be called “Series A Common Shares,” “Series B Common Shares,” etc. The name of the preferred share class issued in a venture round corresponds to the name used for the round (e.g., a “Series A Financing” is one in which “Series A Preferred Shares” are issued).

A shareholder register is a list of all the current and former holders of shares in a company. The register tracks information about shareholders, such as name, address, share class, number of shares held, shares granted to the holder, transfers of shares, date an individual (or entity) became a shareholder, and when an individual stopped being a shareholder. Cyndx Owner allows users to incorporate this information into the cap table to track key holder information.

Created by Y Combinator as an alternative to convertible notes, SAFEs are a special form of preferred stock, junior to debt and senior to equity in a company’s capital structure, which converts to equity following a qualified financing event (i.e., a priced round). SAFEs are favored by early-stage angel and institutional investors, while issuers benefit from delaying pricing equity until the business has grown further. Though SAFEs are like convertible notes in some respects, they do not have a maturity date, nor do they accrue interest.

The number of shares issued upon SAFE conversion is determined based on the share price/valuation set in the next qualified round subject to adjustment for any conversion discount and/or valuation cap features. The shares received by the SAFE holder must mirror the terms of the equity investor shares, subject to a few exceptions.

SAFEs can possess a combination of different features impacting the number of shares issued to SAFE holders upon conversion. These include:

Simple interest is interest that does not compound when accrued. In other words, unpaid interest balances do not add to the principal balance of a security and do not increase the amount of interest the security earns. For example, a security with a $100 principal balance bearing 5% simple interest annually will earn $5 of interest each year. If unpaid interest is allowed to accumulate, it would not increase the amount of annual interest earned (unless explicitly converted to principal).

A stock split is an action approved by a corporation’s Board of Directors that splits each share of the company into multiple shares (a forward stock split) or combines multiple shares into fewer shares (a reverse stock split). This action does not change the value of anyone’s holdings or the company’s equity, nor does it cause dilution. In a forward stock split, each holder receives a certain number of new shares for each share they previously held. The ratio could be 2:1, which would double the number of shares outstanding, or 3:2, 3:1, etc. In a reverse stock split, the ratio could be 1:2, which would halve the number of shares outstanding, or 2:3, 1:3, etc. Conversion ratios on instruments convertible into common stock are adjusted such that the stock split has no impact on their value and economics. The purpose of a stock split for a start-up is to adjust the nominal share price or allow the company to offer stock in smaller increments of value. Accordingly, stock splits are organizational in nature and do not materially impact the economics of a company’s securities and capital structure.

In the context of start-up fundraising, a term sheet is a non-binding agreement for a company to issue securities to one or more investors consistent with certain specified terms. Certain provisions of the term sheet are typically binding such as confidentiality and exclusivity periods. Term sheets are used to facilitate the drafting of definitive documentation on terms mutually agreed upon by the company and investor(s) providing each a measure of comfort that the other party will use best efforts to consummate a deal.

The period following employee termination when an employee remains entitled to exercise their stock options. Grace periods may differ depending on the type of termination (e.g., voluntary or involuntary, death, or disability). The grace period may be limited due to the tax regulations governing certain types of options.

An institutional investment class within private equity focused on providing capital to fast growing start-up and emerging companies. Venture capital firms generally invest on behalf of third parties called Limited Partners (LPs) through pooled investment funds. VCs evaluate companies to source attractive investments with the potential to create outsized returns. Beginning with the Series A round, VCs primarily invest in preferred stock with special rights to protect their investment and influence the direction of companies they select. Some VCs also invest in venture debt and other securities depending on the fund’s mandate and the needs of a particular company. In order to return cash to their LPs, VCs typically seek to exit their investments through a sale of the company or an initial public offering (IPO).

Refers to earning of share-based compensation over time by employees or service providers. Shares or options promised to employees are typically not given out immediately but instead are earned over a period of time or based on performance objectives, much like cash compensation. Upon vesting, an employee receives shares with the rights attending that share class or options that are then exercisable. Notably, unvested securities do not receive any cash in a liquidation/exit unless they are subject to acceleration, which causes them to immediately vest.

Vesting usually occurs on a set schedule (called a vesting schedule) beginning from the vesting start date. Shares or options comprising a grant may vest evenly over a period. For example, 18,000 restricted shares may vest evenly over 36 months at a rate of 500 shares per month.

Often, a vesting cliff applies that sets a minimum amount of time an employee must work before becoming any securities vest. For example, with a 33% vesting cliff on a 36-month vesting schedule, no shares would vest in the first 12 months. Then 1/3 of the shares (6,000 of the shares from the previous example) would vest at the very end of the first year.

Vesting may be subject to acceleration in the event of certain contingencies. There are two kinds of accelerated vesting:

Voting rights convey the ability to vote on certain corporate actions a company may take as required by law and/or defined in the company’s charter. Corporate actions requiring a shareholder vote may include equity issuances, approval of mergers and acquisitions, electing the Board of Directors, appointing corporate officers, and other critical corporate governance matters. Depending on the proposed action, a simple majority (>50%) or a supermajority may be required for approval. Each class of stock issued by a corporation has a specified number of votes per share or no votes. Most often, each share of common stock will have a single vote, but non-voting common shares and super-voting common shares (providing the holder more than one vote per share) are also used. Preferred shares issued to venture capital firms typically have voting rights on an as-converted basis, but terms may vary. Standard SAFEs, on the other hand, do not provide voting rights to the holder.

Warrants are securities that provide the holder the right to purchase either common or preferred shares of a company at a given share price called the exercise price. Warrants differ from stock options in that they are usually issued to investors and commercial partners instead of employees and the exercise price need not reflect the fair market value of the underlying shares. Warrants are often issued in connection with a convertible note, venture debt, or a partnership agreement as a “sweetener” tied to the company’s performance. Some warrants vest over time or based on performance of certain activities by the holder; warrants can also be immediately exercisable. Every warrant has a set term after which it expires (at the expiration date).

Explanation of warrant issuance terms:

Explanation of warrant exercise options:

Warrant coverage is an investment term typically featured in some convertible notes where the holder receives warrants to buy additional shares in the company in an amount equal to a set percentage of the total of principal balance plus accrued interest on the note (subsequently referred to as the P&I balance). The warrant coverage percentage indicates the value of the shares underlying the warrants issued as a percentage of the P&I balance. For example, if the P&I balance is $2 million and the warrant coverage is 10%, the warrants would give the holder the right to purchase $200 thousand in stock. At a pre-money valuation of $20 million with 10 million diluted shares outstanding, implying a $2.00 price per share, the warrants would give the holder the right to purchase 100 thousand shares. The valuation/price per share used to determine how many warrants are issued may vary based on the terms of the note in question. The value of the warrants further depends on the strike price and term to expiration, which are subject to negotiation.

A waterfall analysis is a financial model that illustrates the payout to each holder in a company’s cap table for a given exit valuation. Since many start-up companies have complex capital structures including debt, SAFEs, preferred stock, common stock, employee options, and other securities, calculating the net payout to each interested party can be difficult. Cyndx Owner enables companies to easily run waterfall analyses based on an existing cap table and specific assumptions for future financing rounds and exit valuation. The results show how much cash will be distributed to each security holder including founders, employees, and investors based on the terms of the instruments they hold. The waterfall is important for understanding how much each holder stands to benefit from an exit at a given price. Accordingly, it is critically useful for negotiations with investors and potential acquirers.