📌 Educational Resource Disclaimer
This glossary provides general explanations of common equity terms. These definitions and examples are for educational purposes only and do not constitute legal, financial, or tax advice.
Equity structures vary significantly between companies, and your specific situation may have unique terms and conditions. For guidance on how these concepts apply to your individual situation, please consult with a qualified legal, financial, or tax professional.
Carried Interest
The share of profits that investment fund managers (general partners) receive as compensation for managing the fund, typically 20% of profits above a hurdle rate. Carried interest aligns GP interests with LPs since managers only earn carry when the fund generates returns.
Key characteristics:
Standard rate: 20% of profits (can vary 15-30%)
Only earned after hurdle rate met
Long-term capital gains treatment (if structured properly)
Distributed after LP capital returned
Also called "carry" or "promote"
Common terms:
Hurdle rate: Minimum return LPs must receive before GP earns carry (typically 8%)
Catch-up: GP receives larger share of next profits to reach their 20% overall
Waterfall: Order of distributions (LP capital return → hurdle → catch-up → carry split)
How it works:
Example 1: Simple carry calculation
VC fund raises $100M from LPs
Fund returns $150M to investors
Hurdle rate: 8% ($8M)
Profit above hurdle: $42M ($150M - $100M - $8M)
GP carry: 20% × $42M = $8.4M
LPs receive: $141.6M total
Example 2: With catch-up
Same fund, $150M return
LPs get their $100M capital back
LPs get 8% hurdle: $8M
Remaining $42M: GP gets 100% until they catch up to 20% of total profits
Then 80/20 split continues on remaining proceeds
Typical waterfall structure:
Return LP capital (100% to LPs)
Pay preferred return/hurdle (100% to LPs)
Catch-up (100% to GP until GP has 20% of total profits)
Remaining profits split 80/20 (LP/GP)
Why it matters: Carried interest is how venture capital and private equity fund managers make most of their money. Understanding carry structure helps when evaluating fund economics or considering roles at investment firms.
Convertible Note
A debt instrument that converts into equity at a future date (usually a company’s next priced round). Unlike SAFEs, convertible notes are legally debt, meaning they can have interest rates and maturity dates.
Key terms:
Principal amount: The investment amount
Interest rate: Usually 2-8% annually
Maturity date: When the note is due (typically 18-24 months)
Valuation cap: Maximum valuation at conversion (like SAFEs)
Discount rate: Percentage discount on next round’s price
Conversion triggers: What events cause conversion (usually next equity financing)
What happens at maturity: If the note hasn’t converted by maturity, the company must either:
Repay the principal + interest (often not possible for startups)
Negotiate an extension
Convert at the cap (if allowed by note terms)
Example:
Investor loans $250K via convertible note
5% annual interest, 18-month maturity
$5M cap, 20% discount
After 18 months, company raised Series A at $10M pre-money
Note converts like a SAFE (whichever is better: cap or discount)
Investor gets shares worth $250K + accrued interest (~$18,750)
Feature | SAFE | Convertible Note |
Legal structure | Not debt | Debt |
Interest | No | Yes (2-8%) |
Maturity date | No | Yes (18-24 months) |
Must repay if no conversion | No | Yes |
Complexity | Simpler | More complex |
Popularity | More common (post-2013) | Less common now |
Why it matters: Convertible notes create more pressure than SAFEs because of maturity dates. If the company don’t raise before maturity, it may owe money than it has.
Pre-Money Valuation
The value of a company BEFORE new investment money comes in. This determines how much ownership the new investors will get.
Example:
Pre-money valuation: $10M
Raise: $5M
Post-money valuation: $15M
Investor ownership: $5M ÷ $15M = 33.3%
Why it matters: Pre-money valuation directly determines dilution. A higher pre-money means less dilution for founders and employees.
Post-Money Valuation
The value of a company AFTER new investment money has been added. This is always pre-money + investment amount.
Formula: Post-money = Pre-money + Investment amount
Example:
Pre-money: $10M
Investment: $5M
Post-money: $15M
Post-Money SAFEs: Newer SAFE agreements use post-money valuation caps, which outlines exactly what percentage the SAFE holder gets:
Post-money SAFE: $500K at $5M cap
SAFE holder gets: $500K ÷ $5M = 10% (exactly)
Why it matters: Post-money valuations make ownership calculations clearer and prevent unexpected dilution from multiple SAFEs.
Priced Round
An equity financing where investors purchase shares (usually preferred stock) at a specific price per share, based on a negotiated company valuation. This establishes clear ownership percentages immediately.
Key terms negotiated:
Pre-money and post-money valuation
Price per share
Preferred stock rights and preferences
Board composition
Protective provisions
Example:
Company valued at $10M pre-money
Raise $5M at $2.50/share
Investors get 2,000,000 shares of Series A Preferred
Post-money valuation: $15M
Investors own: 33.3% of fully diluted cap table
Common stages:
Seed Round: Typically $500K-$5M, early product validation
Series A: Typically $5M-$15M, proven product-market fit
Series B+: Typically $15M+, scaling the business
Why it matters: Priced rounds establish clear ownership and valuation, but require more legal work and negotiation than convertible instruments. Used when there’s enough traction to justify a valuation.
Pro-Rata Rights
The right of existing investors to invest in future rounds to maintain their ownership percentage and avoid dilution.
Example:
Investor owns 20% after Series A
The company raising Series B
Pro-rata rights mean they can invest enough to maintain 20% ownership
If Series B is $10M, they can invest $2M (20% of the round)
Why it matters: Pro-rata rights can be valuable for investors but can make it harder to bring in new investors (less room in the round). Often negotiated as part of investment terms.
SAFE (Simple Agreement for Future Equity)
An investment instrument created by Y Combinator where investors give a company money today in exchange for equity later (usually at a company’s next priced round). While SAFEs are not considered debt, they take senior precedence over common shares and may also be senior to preferred shares depending on their structure.
Key terms:
Valuation cap: Maximum valuation at which the SAFE converts
Discount rate: Percentage discount on the next round’s price (if better than the cap)
No interest or maturity date: Unlike convertible notes
Pro-rata rights: Optional right to invest in future rounds
How conversion works: The SAFE holder gets the better deal between the cap and the discount.
Example 1: Cap is better
SAFE investment: $500K with $5M cap and 20% discount
Next round: $10M pre-money at $2.00/share
Cap price: $5M ÷ shares = $1.00/share
Discount price: $2.00 × 80% = $1.60/share
SAFE converts at $1.00/share (cap is better)
SAFE gets: 500,000 shares
Example 2: Discount is better
SAFE investment: $500K with $10M cap and 20% discount
Next round: $8M pre-money at $2.00/share
Cap price: $10M ÷ shares = $2.50/share
Discount price: $2.00 × 80% = $1.60/share
SAFE converts at $1.60/share (discount is better)
SAFE gets: 312,500 shares
Types of SAFEs:
Post-money SAFE: Specifies investor’s exact ownership percentage after conversion
Pre-money SAFE: Ownership depends on when other SAFEs convert
Why it matters: SAFEs are faster and cheaper than priced rounds, making them popular for early-stage fundraising. However, multiple SAFEs can create complex cap table math and unexpected dilution.
SPV (Special Purpose Vehicle)
A legal entity (usually an LLC) created specifically to pool money from multiple investors and invest it as a single entity. SPVs keep cap tables clean by representing many investors as one line item.
How SPVs work:
Lead investor creates “Acme Ventures SPV I, LLC”
Ten angel investors contribute $50K each to the SPV
SPV invests $500K in a company
The cap table shows: “Acme Ventures SPV I, LLC” (not 10 individual angels)
SPV manager handles communication with SPV members
Types:
AngelList syndicates: Online platform for creating SPVs
Lead investor SPVs: VC or angel creates SPV for their round
Founder-led SPVs: Company creates SPV for small investors
Example: Instead of:
Cap Table (messy)
├── Angel 1: 10,000 shares
├── Angel 2: 10,000 shares
├── Angel 3: 10,000 shares
[... 17 more angels]
A company has:
Cap Table (clean)
└── Founder SPV I: 200,000 shares (represents 20 angels)
Pros:
Cleaner cap table
Easier communication (one point of contact)
Simpler legal docs
Easier to manage in future rounds
Cons:
Less direct relationship with individual investors
SPV setup and management costs
Potential for conflicts between SPV members
Why it matters: SPVs are common in seed and Series A rounds. Understanding how they work helps structure early fundraising cleanly.