Know entrepreneurial terms when you're raising money for a startup venture

Words are an indispensable tool in the entrepreneur's toolbox. Well used, they add light, color, symmetry and balance to the entire entrepreneurial venture. But if we use the wrong words or don't understand what words really mean, the result can be disastrous.

As H.R. Haldeman, Watergate co-conspirator, is reported to have said: "If we use words, there is a very grave danger they will be misinterpreted."

Nowhere is that more true for the entrepreneur than in the process of raising money for a startup venture. There is a particular language that is used by investors that must be understood before real communication can flow — not to mention before money can flow.

Following are some typical terms that entrepreneurs need to know so that they can speak the same financial language as potential investors:

— Archangel: A respected leader in the private investor community, often a high net worth individual who can influence other angel investors.

— Dilution: The loss of ownership (as a percentage) that results from selling new company stock to investors.

— Down round: An equity investment (usually stock) at a price lower than previous investors paid. Down rounds can cause extreme dilution to existing shareholders.

— Mezzanine financing: A finance package made up of an unsecured loan combined with a grant of warrants — a mixture of debt and equity that may be short term before permanent financing or equity is obtained.

— Participating preferred: A class of investor stock that, in case of any sale or liquidation, requires the company to pay back the initial investment before any other distributions and also entitles the holder to participate in capital gains along with common shareholders.

Preferred stock usually also carries a dividend rate. This dividend may be accrued until the company is sold.

— Private placement memorandum (PPM): A legal document that is given to potential investors that describes the business and its risks. It is also a document that complies with state and federal securities requirements.

— Term sheet: A simple, plain English memo that outlines the parameters of an investment or loan prior to the formal contract. Term sheets are the basis for negotiation between the investors and the business management.

— Valuation: This is the dollar value of 100 percent of the company stock. The terms pre-money valuation and post-money valuation refer to the dollar value of the stock before an investment is made and after the funds have come in.