Understand key terms used in venture capital financing

Venture capital is still a new concept to many companies seeking to raise capital in Tanzania.

In the fundraising process, many technical terms are normally used to explain key aspects of the transaction.

These terms are normally used in the term sheet, which stipulates the terms of investment, it is important for the investee company to understand these terms before signing the term sheet.

Here is a look of some of the key and common terms used;

Liquidation preference

This means that in the case of exit, when capital has to be divided among shareholders, the owners of shares with liquidation preferences will receive their money first

Anti-dilution rights

These are rights protecting the investors in a current round from future down-rounds of investments (when the valuation is lower than the one on the previous round).

Pro-rata rights

These are rights that allow the existing shareholders to have a first call on newly issued stocks up to the amount needed to prevent dilution. This means that the existing shareholders will preserve the same percentage of the total number of shares regardless of the shares issued.

Redemption rights

This is a way of protection for investors that give them the right to ask to redeem the shares after a certain period of time by asking the company to buy them back at the original purchase price plus dividends. This is done as a way to protect the investors from being stuck with a company that is not likely to exit soon.

Valuation rights

The company’s valuation determines the percentage of the company the VC will own. This guides on who owns what and how much cash each shareholder receives when the company sells.

Valuation is normally expressed in terms of pre-money and post-money values.

• The pre-money valuation is the company’s valuation before the new investment.

• The post-money is simply equal to the pre-money valuation plus
the amount of the new investment.
It is common that the founder’s basic objective is to maximize the amount of capital investment while minimizing dilution. This has in many times happened to be a deal- breaker.

Participation rights

VCs would also use the term “double dipping,” meaning the same thing. Participation rights let preferred shareholders get their money back before anyone else, and then also participate fully (pro-rata) in any remaining proceeds.

Salum Awadh is a CEO of SSC Capital, a corporate and investment advisory firm based in Tanzania and Rwanda, offering capital raising services, M&A, Corporate advisory, research and feasibility studies, business development, funds management, and development advisory.